After Visa Inc. (V) reported that it had handily beat analysts' expectations for its fiscal third quarter earnings results, option traders are taking actions that imply they think the share price will drift lower in the future. Considering the big earnings beat, this may come as a surprise; however, the Visa share price fell 1.6% the day after the report came out. Visa reported earnings per share (EPS) of $1.49 and revenue of $6.13 billion, against analyst predictions calling for EPS of $1.35 and revenue of $5.86 billion. Before the announcement, investors had bid up the share price of Visa, with a large number of call options in the open interest.
Option trading volumes indicated that traders had been buying calls and selling puts; however, the post-earnings option activity suggests that traders' confidence in Visa's share price is waning. That's because the share price has drifted closer to the 20-day moving average, while option activity implies that traders are selling calls and buying puts.
Comparing the price action between stock prices and option trading activity on the days after earnings shows some evidence to suggest that traders may be losing confidence in Visa. The share price fell 1.6% the day after earnings, falling closer to its 20-day moving average. Additionally, call option activity has increased, while implied volatility for these calls has decreased, which suggests that traders are selling call options. This could happen because option traders believe that Visa's share price could fall in the near term.
- Traders and investors sold shares in Visa following the earnings report, as the stock fell 1.6%.
- The share price continued to fall after earnings, closing closer to, but still well above, its 20-day moving average.
- Put and call option activity appears to be positioned for the price to fall from current levels.
- The volatility-based support and resistance levels allow for a stronger move downward than upward.
- This setup creates an opportunity for traders to profit from a reversal in the earnings-based share price decrease.
Option trading represents the activities of investors who want to hedge their long positions or speculators who want to profit from correctly predicting unexpected movement in an underlying stock or index. The choices of these investors imply a forecast for the weeks ahead. That is because option trading is literally a bet on the probabilities of the market—a bet made by traders that are, on average, better informed than most investors. The key to maximizing this insight is to understand the context in which the price behavior took place. The chart below depicts the price action for Visa's shares on Friday, July 30, depicting the setup after the earnings report.
The one-month trend of the stock saw shares closing above the 20-day moving average, before falling 1.6% the day after the announcement and continuing to fall incrementally the day after that. The price closed in the upper region depicted 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 remained in the upper range. This price move from Visa shares implies that investors may be losing confidence in the stock moving forward.
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.
Chart watchers can recognize that traders were expressing optimism going into earnings, based on the price trend for Visa touching its all-time high the day before earnings. Chart watchers can also form an opinion of investor expectations by paying attention to option trading details. Prior to the announcement, traders appeared to be expecting that Visa would move upwards after earnings.
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.
The recent activity of option traders implies that they consider Visa shares overvalued at the current level and have purchased put options as a bet that the stock will close within the box depicted in the chart between today and Aug. 20, the next monthly expiration date for options. The red-framed box represents the pricing that the put option sellers are offering. It implies a 70% chance that Visa shares will close inside this range or below by Aug. 20. So sellers are only mildly bearish. However, buyers are snapping up this pricing, suggesting that buyers consider these options underpriced. Since the pricing implies only a 30% chance that prices could close below this red box, it appears that buyers are willing to take those long odds.
It is important to note that open interest on Friday featured nearly 341,000 call options compared to 269,00 put options, demonstrating the bias that option buyers had, as traders favored calls over puts by a slim margin. This normally implies that option traders expect upwards price movement. After earnings, the volatility has decreased dramatically, but the number of put options in the open interest has remained elevated, and the number of call options increased. Implied volatility for these call options is falling, and this signals that call options are being sold, rather than bought, creating a bearish sentiment.
For the strikes at the money and one step either direction, the put volume far outweighs the call volume. Out-of-the-money call option volume declines at a much faster rate than out-of-the-money put volume, signifying that more traders believe that Visa share prices will fall than those who believe share prices will rise.
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. Although investors and option traders expected positive movement from the report, the share price moved less distance than it did after the last earnings report.
These support and resistance levels show a large range of support and resistance for prices. As a result, it is possible that there could be a large move in either direction in the near future. After the previous earnings announcement, Visa shares rose 1.5% the day after and gradually fell the following week. Investors may be expecting the opposite kind of move in price in the week after this announcement. With lots of room in the volatility range, share prices could rise or fall more than expected in the near term; however, there is more room in the volatility range to support a move to the downside.
While Visa unequivocally beat analysts' expectations for both EPS and revenue, traders sold the stock, as Visa's share price fell closer to it’s 20-day moving average. Option traders have been selling calls and buying puts, reflecting a bearish outlook. This activity provides more room in the volatility range for a downward move in the share price going forward.