After the market closed yesterday, International Business Machines Corporation (IBM) announced its fourth-quarter 2020 earnings report. Immediately after that announcement, traders in the post-market session dropped the share price down to $122.25 per share. Comparatively to what option sellers anticipated before to the earnings report, this fall was greater. Before IBM announced its results, there was a significant negative movement compared to the typical trading range for the company. A move of this size may portend a continuation of the negative trend in the days and weeks to come.
- IBM exceeded its profit goal but fell short of its sales goal.
- Investors had anticipated IBM to rise or at least hold over $126.
- Expected trading ranges shrunk considerably.
Investing in options is a way for investors to safeguard their holdings or for speculators to make money by accurately predicting unforeseen changes in an underlying stock or index. This implies that, in order to maximize profits, option trading necessitates dealing with the best broker since it is essentially a wager on market possibilities. Chart watchers may learn a lot by analyzing the specifics of both stock and option price behavior, but it also helps to comprehend the environment in which this price behavior occurred. The share price of IBM and the setting before the earnings release are shown in the chart below.
As IBM’s share price increased from $123 at the beginning of December to $131 the day before the announcement, the stock’s six-week trend was slightly higher. The price levels that the Keltner Channel indicators on the chart show are multiples of the stock’s average true range (ATR). Over four times the ATR from its initial price in December, IBM’s stock moved higher.
A common method for displaying historical volatility over time is the Average True Range (ATR). One to two weeks of trading on a daily chart are often included in the 10 to 20 time periods that are typically utilized in its computation.
It is simple to demonstrate how IBM’s price trend remained within a stable range over this time using this as a background. Even though IBM sometimes has large price jumps that exceed three times the ATR multiple, these occurrences are the exception and tend to happen less often than 25% of the time. Additionally, recently, when they have happened, they have been a bearish sign.
The Keltner Channel indication shows a series of semi-parallel lines based on an upper and lower line, a simple moving average, and both. 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.
Option traders who saw that IBM had been trading in a calm range may have predicted that the stock would increase significantly following the earnings report. Over 156,000 call options were exchanged on the day before results, compared to just about 52,000 put options, highlighting the bias of option purchasers.
The fact that 48% of the option contracts were executed at strike prices more than three ATR multiples above the closing price indicates that option traders were clearly anticipating extremely favorable news. The implied option price ranges by all option trading before earnings are shown in the chart below.
Option sellers anticipated a range for the announcement between a high of $136.47 and a low of $125.23, as shown by the blue lines. Additionally, it was inferred by the option pricing that there was only a 25% possibility that the price would fluctuate between $122 and $138. At that time, IBM’s implied volatility score was around 35% on average. The options also signaled the likelihood that the share price would finish up between $139 at the high and $120 at the low by the end of the following week, depending on how option sellers had set their pricing prior to results.
The most important information from the earnings release was that IBM exceeded its profit goal by posting profits per share (EPS) of $2.06 as opposed to analysts’ projections of $1.81. With just $20.37 billion in revenues as opposed to the $20.68 billion anticipated, the corporation fell short of its revenue goal. Investors didn’t appear to be paying much attention to anything other than the company’s missed sales goal despite the company’s announcement that it anticipates revenue growth in 2021. The chart below displays the price opening today along with the probability range that has been modified in light of how the market has responded to the earnings report.
The stock’s price began on Friday at $120.70, which is the lowest it has been since before December. The stock’s response caused it to drop below the Keltner Channel average price by many ATR multiples. The price dropped when the market opened the next day and went below the 75% likelihood range predicted by option trading the day before. The indicated price range was lowered lower by the pricing of options the next week, indicating the probability of a downward trend in the stock price. Early on in today’s trading, 84,000 put options and roughly 150,000 call contracts were exchanged, indicating that traders are considerably more negative on IBM than they were before.
IBM is no longer a bellwether stock, but if other technology firms also post results below forecasts, it’s possible that the news of IBM’s sales shortfall may contribute to a more pessimistic sentiment among investors. Unless this occurs, IBM’s findings are unlikely to have a significant influence on exchange traded funds (ETFs) that track the overall market, including State Street’s SPDR S&P 500 ETF Trust (SPY).Surprisingly, a huge number of investors are still hopeful, as seen by the substantial amount of calls being bought.
The Bottom Line
Before the earnings report, option traders purchased IBM call options in large quantities, anticipating highly positive news from the business. IBM dropped 7% after hours as a result of the company’s disclosure, which startled traders and investors. Investors would be expecting to adopt a more gloomy stance on the stock given that the option trading the next day reflected a change downward in the prediction.
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