Investors of Visa Inc. (V) have expressed optimism ahead of the company's fiscal third quarter earnings announcement by bidding up the share price. At first glance, it appears that option traders are predicting a positive move, as there are a growing number of call options in the open interest. The unusual option trading has the potential to create strong downward pressure on the share price if Visa delivers a negative earnings surprise.

A sizable amount of call options remain in the open interest for Visa, and option premiums are unusually high right now. Trading volumes show that traders have been buying calls and selling puts in expectation of a positive earnings report announcement. If these bets were to unwind, it could create unexpected downward pressure on Visa's share price.

Correctly forecasting the direction a stock will move following earnings is challenging. However, a contrast of the stock's price action and option trading activity shows that, if Visa delivers a negative report, the company's share price could fall significantly, moving closer toward its 20-day moving average in the days after the announcement. This could happen because options are priced for a move upwards, but a surprisingly poor report could catch traders off guard and create a swift decline in share price.

Key Takeaways

  • Traders and investors have bid up the Visa share price to an extreme range before the earnings report.
  • The share price has been closing over its 20-day moving average, having recently found its all-time high.
  • Call and put is predicting a stronger move upwards.
  • The volatility-based support and resistance levels allow for a larger move to the downside. 
  • This setup creates an opportunity for traders to profit from an unexpected earnings report.

At its core, option trading represents the actions of investors who wish to protect their positions, or speculators who desire to profit from correctly predicting unexpected moves in an underlying stock or index. That makes option trading a literal bet on market probabilities. By comparing the details of both share price and option behavior, chart watchers can gain valuable insight, although it is beneficial to understand the context in which this price behavior took place. The chart below depicts the price action for the Visa share price as of Monday, July 26. This created the setup heading into the earnings report announcement.

Earnings Pricing for Visa Inc. (V)

Current Trends

The one-month trend of Visa stock has the share price briefly testing lower support levels near the 20-day moving average, before rising toward the extremes of the volatility range. Over this time period, it's notable that the lowest Visa share price was around $232 in late June. The highest share price over the past month was approximately $250, an all-time high, the day before the report was due to be announced. The price closed in the upper region shown by the technical studies on this chart.

The studies are formed by 20-day Keltner Channel indicators. These depict price levels that represent a multiple of the Average True Range (ATR) for the stock. This array helps to highlight the way the price has moved to a higher range in the week before earnings. This price move from Visa shares implies that investors expect a positive earnings result.

Tip

The Average True Range (ATR) has become a standard tool for depicting historical volatility over time. The typical average length of time used in its calculation is 10 to 20 time periods, which includes two to four weeks of trading on a daily chart.

In this context where the share price trend for Visa has risen toward an extreme range, chart watchers can recognize that investors and traders are showing optimism headed into the earnings announcement. In the week before earnings, Visa's share price fell closer toward the 20-day moving average before rallying to its all-time high. That makes it important for chart watchers to surmise whether the move is indicative of investors' expectations for a favorable earnings report or not.

Option trading details can provide extra context to help chart watchers form an opinion about investor expectations. Recently, option traders are favoring calls over puts by an increasing margin. Normally, this suggests that investors are expecting a positive earnings report and that traders appear to be expecting that Visa will continue to trend higher after earnings.

Tip

The Keltner Channel indicator displays a set of semi-parallel lines based on a 20-day simple moving average and an upper and lower line. Because the upper lines are drawn by adding a multiple of ATR to the average and the lower lines are drawn by subtracting a multiple of ATR from the average price, then this channel indicator makes for an excellent visualization tool when charting historical volatility.

Trading Activity

Option traders recognize that Visa shares are in an extreme range and have priced their options as a bet that the stock will close within one of the two boxes depicted in the chart between today and July 30, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 35% that Visa shares will close inside this range by the end of the week if prices go higher. The red box represented the pricing for put options with a 32% probability if prices go lower on the announcement.

It's important to note that the open interest featured over 316,000 active call options compared to roughly 245,000 put options, demonstrating the bias that option buyers had, as well over half of the trades were call options. This amount normally implies that call option traders expect an increase in price. However, because the call box and put box are relatively equal in size, it tells us that the high percentage of call options traded has only mildly skewed expectations higher. It should be noted that, on Monday, the day before the earnings announcement was to be released, the trading volume favored calls over puts by a ratio of 2.5-to-1.

Option Pricing for Visa Inc. (V)

The purple lines on the chart are generated by a 10-day Keltner Channel study set at four times the ATR. This measure tends to create highly correlated regions of strong support and resistance in the price action. These regions show up when the channel lines make a noticeable turn within the previous three months.

The levels that the turns mark are annotated in the chart below. What is notable in this chart is that the call and put pricing are in such a close range with plenty of space to run downwards compared to upwards. This suggests that option buyers don't have a strong conviction about how the company will report, even though calls are being purchased over puts. Although investors and option traders do not expect it, a surprising report would push prices dramatically higher or lower.

Volatility Pattern for Visa Inc. (V)

These support and resistance levels show a large range of support and resistance for prices. As a result of this, it is possible that any news, surprisingly bad or good, will catch investors by surprise and could generate an unusually large move. After the previous earnings announcement, Visa shares rose by 1.5% in the day following and gradually fell the following week, before moving below the 20-day moving average. Investors may not be expecting the same kind of move in the price after this announcement. With plenty of room in the volatility range, share prices could rise or fall more than expected.

Market Impact

Visa shares typically make mild moves after earnings, so the result most likely won't move index prices directly. However, no matter what the report says, it will likely have a significant impact on stocks in the financial sector. A positive report could lift other stocks in the sector such as Mastercard Incorporated (MA) or PayPal Holdings, Inc. (PYPL). It would also affect exchange-traded funds (ETFs) such as State Street's Technology Sector Index ETF (XLK) and potentially State Street's S&P 500 Index ETF (SPY).