Option traders are acting in a manner that suggests they believe the share price will decline in the future after Berkshire Hathaway Inc. (BRK.B) disclosed that it had surpassed analysts’ expectations for its fiscal second quarter earnings results. Given that the share price only increased by less than 1% the day following the announcement, this could come as a surprise.
Analyst forecasts were surpassed by BRK.B’s sales of $64.4 billion and net income of $11.71 billion. Investors had maintained the share price range bound before to the announcement, with a discernible number of call options in the open interest.
Option activity after results suggests that traders are losing faith in BRK.B’s share price moving ahead. Option trading volumes suggest that traders had been buying calls and selling puts. The reason for this is that the price action has broken through resistance and is now in the higher part of the volatility range, whilst the option activity suggests that traders are dumping calls and buying puts.
- Following the release of the results report, traders and investors purchased shares of BRK.B as the stock increased by less than 1%.
- The price of BRK.B’s stock finished significantly higher than its 20-day moving average.
- The share price looks to be positioned for a decline based on put and call option activity.
- The support and resistance levels based on volatility permit a more forceful move to the negative.
- Trading opportunities are presented by this setup should the earnings-based share price gain reverse.
Trading options is essentially a gamble on market possibilities, one that is placed by traders who, on average, have more knowledge than other investors. Understanding the background of a price change is essential to maximize insight into option trading. The price activity for BRK.B’s share price as of August 9 is seen in the chart below, showing the setup after the earnings announcement.
With the exception of two days in mid-July, the stock’s one-month trend showed the share price staying slightly above the 20-day moving average before finishing in the top third of the volatility range shown by the technical analyses on this chart.
Indicators from the 20-day Keltner Channel are the basis of these analyses. These are price levels that are multiples of the stock’s average true range (ATR). This array makes it easier to see how the price has increased from the center to the top third of this range. This price change in BRK.B shares suggests that market participants now have more faith in the company’s future share price.
A common method for displaying historical volatility over time is the Average True Range (ATR). Two to four weeks of trade on a daily chart are often included in the 10 to 20 time periods that make up the standard average length of time utilized in its computation.
Based on the price trend for BRK.B closing above its 20-day moving average before increasing 1.9% the day before the results release, chart watchers may see that traders were feeling upbeat heading into earnings. By focusing on the specifics of option trading, chart watchers might also develop an opinion on investor expectations. Before the release, it seemed like traders anticipated that BRK.B shares would rise following the report.
A 20-day simple moving average, an upper and lower line, and a series of semi-parallel lines are shown by the Keltner Channel indicator. This channel indicator provides for a fantastic visualization tool for charting historical volatility since the higher lines are produced 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.
The recent behavior of option traders suggests that they believe BRK.B shares are overpriced. As a result, they have purchased put options in an effort to predict that the stock would close between now and August 20, the next monthly option expiry date, within the box shown on the chart. The price that the put option sellers are providing is shown by the red-framed box. By August 20, there is a 68% likelihood that the price of BRK.B shares will settle inside this range or lower. Sellers are thus just somewhat bearish. Buyers, however, are grabbing these prices, indicating that they believe these options are underpriced. It seems that purchasers are ready to face the long odds since the pricing suggests that there is only a 32% possibility that prices will close below that box.
It is significant to notice that on August 9, open interest consisted of more than 300,000 call options vs more than 199,000 puts, highlighting the bias among option traders because more than 60% of the options were calls. This often means that option traders anticipate an increase in price. After results, volatility dropped significantly, but the open interest in call options is still quite high.
The call volume exceeds the put volume for strikes at the money and one step in either direction, indicating that more traders anticipate an increase in share prices for BRK.B than a decrease. Although call options are traded in significant numbers, it should be observed that the implied volatility of this volume is decreasing, suggesting that call options are being sold rather than bought.
The 10-day Keltner Channel research with a four-times ATR setting produced the purple lines on the graph. With this metric, the price action is more likely to produce zones of strong support and resistance that are strongly connected. When the channel lines have recently made a considerable turn, these areas become visible.
The graphic below includes annotations for the levels that the turns designate. The call and put prices in this chart are noticeably different, and there is greater room for downward movement. This implies that option purchasers are more certain than usual that the price would decline in the weeks after the report. The share price rose less than it did after the last earnings announcement, despite the fact that investors and option traders had anticipated upward movement from the report.
These levels of support and resistance demonstrate a wide range of price support and resistance. As a consequence, it’s probable that there may be a significant movement in either way soon. Shares of BRK.B increased 1.54% the day after the prior results report and kept increasing during the following week. Investors can anticipate a different sort of price movement in the week after this news. Share prices may increase or fall more than anticipated in the near future due to the wide volatility range; nonetheless, there is more space in the volatility range to support a move to the downside.
Both the company’s sales and profits per share (EPS) exceeded analysts’ predictions. The day following the announcement, the share price increased by less than 1% and has since climbed to the top third of the volatility range, closing above the 20-day moving average. Options traders seem to be buying puts and selling calls, which indicates a pessimistic outlook. Due to this action, there is now greater space in the volatility range for a future decline in the share price.
Option Trading Example
Unusual option activity, as a wager on market possibilities, may provide traders insight into investor perceptions of the firm and show what the “smart money” is doing with huge volume orders. Opening a debit put spread is one approach to take advantage of the pessimistic mood shown in the post-earnings activity of Berkshire Hathaway option traders.
In a debit put spread, a sort of vertical spread, two put options with the same expiry date but different strike prices are simultaneously bought and sold. This approach is predicated on the assumption that the stock would decline in value, increasing the value of the acquired put option despite the transaction’s original cost. The share price of BRK.B falling to or below the option’s strike price would be the best-case scenario. This would minimize risk while generating the greatest possible reward.
For instance, purchasing the Sept. 10 $290 option costs $8.10 and has a breakeven price of $281.90 to reflect the negative mood. Selling the $280 put on September 10 will result in a $2.42 credit, with a breakeven price of $277.58. The net negative for this transaction, which includes purchasing the $290 put and selling the $280 put, is $5.68, or $568 per contract. At expiry, the trade’s breakeven price is $284.32 (data snapshot taken at 3:59 EDT on August 9, 2021). The setup for this specific debit put spread is seen in the chart below.
A danger exists with any plan. The total debit paid for the deal, or $568 per contract, represents the maximum risk on this transaction. Instead of purchasing a naked put option, this technique sells a put option with a lower strike price than the one that was bought, capping the possible profit. The highest benefit for this specific scenario is $432. Calculating $432 / $568 = 76% gives us the probable return on risk for this strategy.
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