Eli Lilly (LLY) Option Traders Confident After Earnings

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Eli Lilly (LLY) Option Traders Confident After Earnings

After Eli Lilly and Company (LLY) disclosed that its fiscal second quarter financial results fell short of analysts’ expectations, option traders are taking moves that suggest they believe the share price will rise in the future. This is hardly surprising given that the stock price gained 2.5% the day following the announcement.

Eli Lilly announced earnings per share (EPS) of $1.87 and sales of $6.74 billion, below analysts’ forecasts of $1.89 but above revenue projections of $6.59 billion. Prior to the announcement, investors drove LLY’s share price to an all-time high, with a huge number of sold put options in the open interest.

Option trading volumes show that traders were buying calls and selling puts; nonetheless, option trading activity after earnings implies that traders are still bullish on LLY’s share price in the future. This is because price action has stayed in an extreme range, indicating that traders continue to purchase calls and sell options.

Key Takeaways

  • Following the results report, traders and investors purchased LLY stock, which increased 2.5%.
  • LLY’s share price has remained above its 20-day moving average.
  • Put and call option activity appears to be positioned for a rise in the share price.
  • The volatility-based support and resistance levels allow for a stronger move to the downside.
  • This setup creates an opportunity for traders to profit from a reversal in the earnings-based price movement.

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 LLY’s share price on August 9, showing the setup after the earnings release.

Current Trends

The stock’s one-month trend saw it surge over the higher ends of the volatility range, finishing far above the 20-day moving average and at the highest extremes of the 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 serves to indicate how the price has surpassed the volatility range’s top boundaries. This price movement in LLY shares indicates that investors are incredibly optimistic in LLY’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 LLY closing near the higher extremities of the volatility range, chartists may see that traders were exhibiting confidence heading into results. 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 LLY shares to rise 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 LLY 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 Aug. 20, 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 LLY shares will finish inside this range or higher by August 20. 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 August 9 included over 65,000 call options vs over 90,000 puts, illustrating the bias that option purchasers had, since this generally signals that option traders predict negative price movement. 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 analysis set at four 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 favorable movement from the report, the share price rose more than it did following the last earnings announcement.

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. LLY shares declined less than 1% the day after the prior results report before gaining the following week. Investors may anticipate a similar 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.

Wrapping Up

LLY exceeded sales projections but fell short of earnings per share estimates. The stock surged 2.5% the next day following the announcement and has since maintained at the top end of the volatility range, finishing considerably above the 20-day moving average. Option traders seem to be purchasing calls and selling puts, implying a positive view. This action, however, leaves more space in the volatility range for a future decline in the share price.

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Option Trading Example

Unusual option activity, as a gamble on market possibilities, may provide traders with insight into investor attitude toward the firm and show what “smart money” is doing with huge volume orders. Opening a debit call spread is one approach to catch the optimistic enthusiasm indicated in LLY’s post-earnings activity.

A debit call spread, a sort of vertical spread, is an option strategy in which two call options with the same expiry date but different strike prices are purchased and sold at the same time. Despite the transaction’s initial cost, this technique is predicated on the expectation that the stock’s price will climb in the future, making the acquired call option more valuable. The best-case scenario would be for LLY’s share price to climb to or over the option’s strike price. This would provide the most benefit while minimizing risk.

To catch the bullish emotion, purchase the Sept. 10 $260 call for $12.40, with a breakeven price of $272.40. Selling the September 10 $275 call will result in a $4.40 credit, with a breakeven price of $279.40. The net deficit for this transaction is $8.00, or $800 per contract, after purchasing the $260 call and selling the $275 call. The trade’s breakeven point at expiry is $268 (data snapshot as of 3:59 EDT, 8/9/2021). The setup for this specific debit call spread is seen in the chart below.

No approach is risk-free. The total debit paid for the deal, or $800 per contract, is the maximum risk on this trade. Because this technique sells a call option with a higher strike than the one acquired, the potential profit is limited compared to merely purchasing a call option. The greatest possible profit in this scenario is $700. This trade’s potential return on risk is computed as $700 / $800 = 87.5%.

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