Will Shopify (SHOP) Succumb to Payment Processor Trend?

The share prices of Shopify Inc. (SHOP) remain in a downward trend as the company prepares to report earnings for the fiscal fourth quarter. Shopify stock has drifted lower with the technology sector as inflation fears have spiked and is currently trading nearly 50% off its 52-week highs. Analysts expect the e-commerce company to report $1.31 in earnings per share (EPS) and $1.34 billion in revenue. Investors will be looking to see if Shopify can get back to beating analyst' estimates or if the company will miss expectations as it did last quarter.

While the technology sector has been one of the worst performing of the S&P 500 of late as concerns over potential interest rate hikes have increased, Shopify has underperformed its sector. Post-earnings price action in other online payment processors and e-commerce stocks have dragged Shopify shares lower ahead of the earnings report.

Option traders are positioning themselves for the Shopify downward trend to continue. That's because the open interest and recent trading volumes skew toward long put options, as investors appear to be taking advantage of elevated premiums ahead of earnings to sell call options.

Recent Technology Sector Performance

While Shopify is far from one of the top holdings of State Street's Technology Sector ETF (XLK) by weight, it's helpful to take note of recent trends in the sector compared to the overall market. XLK has fallen 11.7% year to date, while State Street's S&P 500 Index ETF (SPY) has slid 8% in the same time frame. Meanwhile, Shopify shares have lost a whopping 37.8% since the start of 2022. The chart below illustrates the recent performance of Shopify stock compared to XLK and nine of the top sectors of the S&P 500.

The technology sector has experienced a recent downturn as the market has braced for the Federal Reserve's planned interest rate hikes and end of quantitative easing in order to combat rising inflation. In an inflationary environment, tech stocks tend to underperform, as large debt on their balance sheets becomes more expensive to hold. Rising interest rates, which counter inflation, could also reduce high-growth tech companies' future earnings and bottom line.

Rough Go for Payment Processors

While Shopify provides a platform for small business owners to operate their business, the company could be considered a payment processor. Investors could be concerned that rising interest rates to counter inflation could put a cramp on consumer spending, which in turn could affect the bottom line of Shopify's small business operators.

Recent stocks that execute similar business to Shopify have not fared well after earnings. While Block, Inc. (SQ) has yet to report, both Affirm Holdings, Inc. (AFRM) and PayPal Holdings, Inc. (PYPL) faced steep slides following the release of their respective earnings reports. The chart below compares Shopify with several digital payment companies, as well as established long-term credit companies Mastercard Incorporated (MA) and Visa Inc. (V).

It's notable on this chart that, while digital payment processors have dragged lower since December, Visa and Mastercard have remained relatively flat. This could be because Visa and Mastercard are primarily credit businesses, which stand to benefit from rising inflation, as growing interest rates putting a cramp on consumer spending could result in an increase in credit usage. This increase in credit use could improve the bottom line of these traditional credit companies, while digital processors don't face the same benefit.

Price Action

An analysis of recent option activity combined with technical analysis of share price movement can help chart watchers gain valuable insight into the overall sentiment toward Shopify stock. The chart below depicts the recent price action for the Shopify share price as of Monday, Feb. 14.

This chart highlights how Shopify stock embarked on an extended downward trend shortly after reporting earnings for the prior quarter. The share price drifted to an extreme high of the volatility range after earnings and has remained in a downward trend since, highlighted in blue. The Shopify share price has recently moved off the extreme low of the volatility range but continues to close below the 20-day moving average.

The purple bands on this chart are an extreme historical volatility range formed by 4 standard deviations of 20-day Keltner Channel indicators, which depict price levels that represent a multiple of the average true range (ATR) for Shopify stock. ATR is a standard tool for illustrating historical volatility over time. These bands could be considered to represent the extreme ranges of option pricing. It's notable that these bands have remained at a relatively wide level, indicating that option traders could be unsure of the earnings outcome.

Volume Profile and Options Look

Price action alone can theoretically indicate the overall sentiment toward any particular stock. However, providing further context to this price action can paint a clearer picture, while illuminating key details for chart watchers. The chart below illustrates the recent price action of Shopify, in addition to a price-based volume pattern on the left-hand side.

The price-based volume pattern illustrates the prices where investors have bought and sold the shares previously. When volumes at a given price are scant, it implies that few, if any, investors have positions to defend at these levels. A significant amount of buying in the past often implies that traders and investors feel the need to defend their positions at those same prices by either buying more shares or at least not selling further.

There are two notable zones of price-based volume activity on this chart. These two zones are thin on volume, and what little volume they do have is primarily selling. They are highlighted on this chart by the red rectangles. These areas could prove to be upside resistance if the Shopify price action were to rise after earnings.

Recent option trading volumes on Monday for Shopify favor calls (19,000) over puts (12,000). However, over the last five trading days, the Shopify open interest for call options has fallen by 1.5%, while the put/call ratio has risen 1.5%. In addition, the open interest for Shopify features 114,000 calls compared to 122,000 puts.

For Feb. 18, the next monthly option expiration date, the single option with the highest open interest is the $1,100 call, with 3,600. This represents 30% upside from the current share price. While Feb. 18 open interest favors calls over puts—39,000 to 25,000—implied volatility suggests that option traders are placing overall bearish bets toward Shopify earnings.

That's because, while the number of upside calls outnumbers downside puts, implied volatility for these calls options is declining as the open interest is rising, suggesting that option traders are taking short positions in these options. Similarly, implied volatility for downside puts is rising as the open interest is rising, indicating that traders are buying these options.

Ahead of earnings, implied volatility tends to be at its highest. This creates an environment that is beneficial, yet risky, to option sellers attempting to capture volatility decay after a stock reports earnings. While implied volatility is rising, the skew of this volatility is very bearish. Implied volatility skew shows the market's bias for pricing in volatility risk to the option premium of downside puts and upside calls. If the implied volatility for downside puts is increasing relative to upside calls, then that suggests the market is pricing in for a larger fear of a downside move. Current skew is trending higher, which translates to a bearish outlook for Shopify stock.

Wrapping Up

While the technology sector has drifted lower since the beginning of 2022, Shopify stock has faced a much steeper decline, down 37% in this time. Digital payment processor stocks have fared poorly after reporting earnings, and option traders appear to be positioned for the same outcome for Shopify. That's because traders appear to be selling upside calls while buying downside puts.