Best Buy (BBY) Option Traders Bullish After Earnings

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Best Buy (BBY) Option Traders Bullish After Earnings

After Best Buy Co., Inc. (BBY) disclosed that its fiscal second quarter profits results above analysts’ forecasts, option traders are taking measures indicating that they believe the share price will rise in the future. This may come as no surprise given that the stock price increased 8.3% the day following the announcement. Best Buy announced profits per share (EPS) of $2.98 and sales of $11.85 billion, beating expectations of $1.85 EPS and $11.49 billion in revenue. Prior to the news, investors had reduced the share price of BBY to a below-average level.

Traders and investors had bid down BBY’s share price before to results; however, option trading activity after earnings suggests that traders’ confidence in BBY’s share price in the future has increased. This is due to the fact that price action has climbed to an above-average range, while option activity and open interest indicate that traders are buying call options and selling puts.

Key Takeaways

  • Traders and investors bought shares of Best Buy following the earnings announcement, as the stock rose 8.3%.
  • The share price of BBY closed well above its 20-day moving average.
  • The put and call option activity looks to be positioned for the stock price to grow further.
  • Support and resistance levels depending on volatility allow for a bigger move to the negative.
  • This setup provides traders with the possibility to benefit from a reversal in the earnings-based price gain.

Option trading is a literal gamble on the market’s probabilities—a bet made by traders who, on average, are more educated than most investors. Understanding the circumstances in which the price change occurred is critical to maximizing insight in option trading. The chart below depicts the price activity for BBY’s share price on August 24, showing the setup after the earnings release.

Current Trends

The stock’s one-month trend saw it dip below the 20-day moving average in the week before results, then surging significantly above it following the release, finishing in the top third of the volatility range shown by the technical studies on this chart. The 20-day Keltner Channel indicators are used to create these studies. These are price levels that are multiples of the stock’s Average True Range (ATR). This array emphasizes how the price has increased to the top third of the volatility range. This price movement in BBY shares suggests that investors are becoming more confidence in BBY’s share price in the future.

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Tip

The Average True Range (ATR) has become a widely used technique for illustrating historical volatility over time. The average amount of time employed in its computation is 10 to 20 time periods, which comprises two to four weeks of everyday trading.

Based on the price trend for BBY falling below the 20-day moving average, chartists may see that traders were expressing pessimism heading into earnings. By paying attention to option trading data, chart watchers may generate an opinion on investor expectations. Prior to the release, it seemed that traders expected BBY shares to fall following results.

Tip

The Keltner Channel indicator shows a series of semi-parallel lines based on a 20-day simple moving average, as well as an upper and lower line. Because the higher lines are produced by adding a multiple of ATR to the average price and the lower lines are drawn by subtracting a multiple of ATR from the average price, this channel indicator is an ideal visualization tool for displaying historical volatility.

Trading Activity

Options traders’ recent activity suggests that they believe BBY shares are cheap and have purchased call options in the hope that the stock would close inside the box illustrated in the chart between now and Sept. 17, the next monthly expiry date for options. The price offered by call option sellers is shown by the green-framed box. It means that there is a 70% likelihood that BBY shares will finish inside this range or higher by September 17. As a result, sellers are just modestly optimistic. Buyers, on the other hand, are picking up this pricing, implying that these choices are underpriced. Given that the pricing assumes just a 30% possibility that prices would close above the green box, it suggests that purchasers are ready to accept the long odds.

It is worth noting that open interest on Tuesday included over 89,000 call options vs over 101,000 puts, illustrating option buyers’ bias. This usually means that option traders anticipate a decline in price. Volatility has fallen considerably after results, yet the quantity of put options in open interest has climbed. This indicates a bearish attitude.

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The call volume outnumbers the put volume for strikes at the money and one step either way. Out-of-the-money put volume falls far more slowly than out-of-the-money call volume. However, it should be observed that the implied volatility of this put option volume is decreasing, suggesting that put options are being sold more than bought, despite the fact that they are being traded in huge numbers.

A 10-day Keltner Channel study set at 4 times the ATR yielded the purple lines on the chart. This metric creates closely connected price action zones of strong support and resistance. These areas appear when the channel lines have made a noteworthy turn during the last three months.

The levels marked by the turns are noted in the chart below. What stands out in this chart is the wide discrepancy between call and put prices, which has lots of room to fall. This shows that option purchasers are more confident that the price will rise in the weeks after the report. Despite the fact that investors and option traders anticipated the report to be bad, the share price rose more than it did following the last earnings release.

These support and resistance levels demonstrate a wide variety of price support and resistance. As a consequence, a significant shift in either way is probable in the near future. Next the prior results report, BBY shares dropped 1.6% the next day and continued to decrease the following week. Investors may anticipate a different kind of price movement in the week after this release. Because there is a lot of space in the volatility range, share prices might increase or fall more than anticipated in the short term; nevertheless, there is more capacity in the volatility range to support a move to the downside.

Bottom Line

Best Buy outperformed analysts in terms of revenue and earnings per share. The share price rose 8.3% the next day, moving to the top third of the volatility range and closing well above its 20-day moving average. Option traders appear to be purchasing calls and selling puts, implying a bullish outlook. This activity, however, leaves more room in the volatility range for a future decline in the share price.

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Option Trading Example

As a bet on market probabilities, unusual option activity can offer traders insight into investor sentiment toward the company and illustrate what “smart money” is doing with large volume orders. One way to capture the bullish sentiment reflected in the post-earnings activity of BBY would be to open a calendar spread.

A calendar spread, also known as a horizontal spread, is an option strategy that involves simultaneously buying and selling two of the same type of options with different expiration dates but the same strike prices. Calendar spreads allow traders to construct a trade that minimizes the effects of time. A calendar spread is most profitable when the underlying asset does not make any significant moves in either direction until after the near-term option expires.

For example, to capture BBY’s bullish sentiment, selling the Sept. 17 $125 call will deliver a credit of $2.18 and has a breakeven price of $127.18. Buying the Dec. 17 $125 call costs $7.00 and has a breakeven price of $132. After selling the Sept. 17 call and buying the Dec. 17 call, the net cost for this trade is $4.82, or $482 per contract (data snapshot as of 3:59 EDT, 8/24/2021). The idea behind this trade is to capture the short-term upward trend. The chart below illustrates the setup for this example.

No strategy is without risk. The maximum risk on this trade is the amount paid to open the positions, or $4.82 per contract. Calculating the maximum profit on a calendar spread at the outset is difficult, as the maximum profit is equal to the time value left in the bought option at the sold option expiration, minus the net debit (or cost of the trade) (or cost of the trade).However, professional traders target a profit of 15% to 30%.

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