Walmart (WMT) Option Traders Oddly Optimistic

As Walmart price action drifts lower, traders gauge the probability of a jump

Traders have pushed down the share prices for Walmart Inc. (WMT) ahead of its quarterly earnings announcement. Despite this, option traders have paid a premium expecting the stock to rise. It seems to imply that they are expecting very good news. There's no way to accurately predict the direction a stock will move after an earnings announcement. However, a comparison of the price action between stock prices and option prices shows that if Walmart shares jump, diverging away from its 20-day moving average in the first few days after the announcement, uptrend-focused traders are in a position to capture the best profits.

Key Takeaways

  • Traders and investors have driven the price of Walmart shares lower heading into the announcement.
  • Walmart's stock price has been closing well above its 20-day moving average. 
  • Put options are priced for a larger drop and call options for a smaller gain. 
  • The volatility-based support and resistance levels allow for a strong move in either direction. 
  • This setup creates an opportunity for traders to profit from an unexpected result.

Option trading represents the activities of investors who want to protect their positions or speculators who want to profit from correctly forecasting unexpected moves in an underlying stock or index. That means option trading is literally a bet on market probabilities. By comparing the details of both stock and option price behavior, chart watchers can gain valuable insight, although it helps to understand the context in which this price behavior took place. The chart below depicts the price action for Walmart's share price and the setup leading into the earnings report.

Chart showing the share price performance of Walmart Inc. (WMT) before earnings

Current Trend

The one-month trend of the stock has the shares remaining in a medium range with a slight downward trend. It is notable that over the past month Walmart fell to $139 per share at the beginning of February with only a slight retracement as the announcement day draws near. The price closed in the middle region depicted by the technical studies on this chart. The studies are formed with 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 from the lower extreme back to its average range and held in that range. This price move for Walmart shares implies that investors may be cautiously optimistic for the upcoming report.

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 one to two weeks of trading on a daily chart.

In this context where the price trend for Walmart has been holding in a middle range, chart watchers can recognize that traders and investors are expressing uncertainty going into earnings. That makes it important for chart watchers to determine whether the move is reflecting investors' expectations for a favorable earnings report or not. 

Option trading details can provide additional information to help chart watchers form an opinion about investor expectations. Option traders are favoring calls over puts, suggesting that investors are expecting good news from the company report. Supporting evidence can also be found in the comparison of the volatility range depicted on the chart by the purple lines and the purple box in the background. Even though prices have remained in such a tight range, they are drifting toward the upper half of the volatility range. This position for the price suggests that investors may not be as pessimistic as it appears.

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, this channel indicator makes for an excellent visualization tool when charting historical volatility.

Trading Activity

Option traders recognize that Walmart shares are average 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 Feb. 19, the Friday after the earnings report is released. The green-framed box represents the pricing that the call option sellers are offering. It implies a 72% chance that Walmart shares will close inside this range by the end of the week if prices go higher. The red box represents the pricing for put options with a 74% probability that prices go lower on the announcement.

It is important to note that trading on Tuesday featured over 69,000 call options traded compared to roughly 28,000 put options, demonstrating the bias that option buyers had. That only 28% of the trades were put options implies that option traders are slightly optimistic, as shown in the chart below.

Chart showing Walmart (WMT) Inc. call and put pricing

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 on either side to run. This suggests that option buyers don't have a strong conviction about how the company will report. However, the put option range is much larger than the call option range, suggesting that investors have their doubts about the company's results.

Chart showing Walmart Inc. (WMT) volatility range


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, Walmart shares rose by under 2% in the days following. Investors may not be expecting the same kind of small move in price after this announcement. With lots of room in the volatility range, share prices could rise or fall more than expected.

Market Impact

The effect of Walmart's earnings report is influential to the market because of the company's size. Even so, Walmart shares typically make only mild moves after earnings, so the result doesn't move index prices directly. However, no matter what the report says, it will likely have a significant impact on stocks in the consumer staples sector. With more than 50% of S&P 500 components having reported earnings by now and a large majority of them beating estimates, investors will expect Walmart to beat estimates. Anything less would be a shock. A positive report could lift consumer staples stocks and exchange traded funds (ETFs) such as State Street's Consumer Staples Select Sector SPDR Fund (XLP), but a negative surprise would not only weigh on XLP but on broad market issues such as State Street's SPDR S&P 500 ETF Trust (SPY).  

The Bottom Line

Option traders on Walmart favored call options by a strong margin over put options before the company's earnings announcement. Investors are clearly expecting good news even though they've been selling shares lower lately. If a bad report does materialize, Walmart shares could drop substantially, but traders are discounting that possibility. Right now, the call options are priced for Walmart to make a taller-than-usual jump. This implies that options traders are anticipating very good news or that they have wildly overpriced the call options. The volatility price range size is enough to exceed both call and put pricing, allowing for a large move. However, Walmart shares are not known for making strong moves in the five days after an earnings announcement.