When International Business Machines Corporation (IBM) announced its fourth-quarter 2020 earnings report after the market closed yesterday, traders in the post-market session liquidated the stock for as low as $122.25 immediately after. This was a higher drop than option sellers anticipated prior to the results presentation. The drop was substantially bigger than IBM’s normal trading range before the results release. A shift of this size might indicate a prolonged downward trend in the coming days and weeks.
- IBM exceeded its profit objective but fell short of its sales aim.
- Traders predicted IBM to rise or at least remain over $126.
- Expected trading ranges have shrunk dramatically.
Investors who wish to safeguard their holdings or speculators who seek to benefit from accurately projecting unexpected swings in an underlying stock or index engage in option trading. That is, option trading is essentially a wager on market possibilities, which necessitates working with the finest broker to get the most out of it. Chart watchers may acquire significant information by analyzing the intricacies of both stock and option price behavior, albeit it helps to understand the context in which this price behavior occurred. The chart below displays IBM’s share price activity and the setup building up to the earnings release.
The stock’s six-week trend was slightly higher, with IBM rising from $123 per share in early December to $131 per share the day before the announcement. The Keltner Channel indicators on the chart reflect price levels that are a multiple of the stock’s Average True Range (ATR). IBM’s price increase was more than four times the ATR from its initial price in December.
The Average True Range (ATR) has become a widely used technique for illustrating historical volatility over time. The average number of time periods employed in its computation is 10 to 20, which encompasses one to two weeks of trade on a daily chart.
Using this as a background, it is simple to demonstrate how IBM’s price trend remained within a narrow range over this time period. Although IBM sometimes experiences a price increase more than three times the ATR multiple, such movements are the uncommon and seem to occur fewer than 25% of the time. Furthermore, when they do occur, they have recently proven a negative indicator.
The Keltner Channel indication shows a series of semi-parallel lines based on a 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.
Recognizing that IBM had been in a peaceful trading range, option traders may have expected that the stock would make a strong move upward after the results release. Over 156,000 call options were exchanged on the day before results, compared to approximately 52,000 put options, illustrating the bias that option purchasers had.
Clearly, option traders were anticipating extremely favorable excellent news—so much so that 48% of those option bets were placed on strike prices that were more than three ATR multiples above the closing price. The figure below displays the implied option price ranges based on all option activity prior to earnings.
The projected range for option sellers (indicated by blue lines) was between a high of $136.47 and a low of $125.23. The option pricing also showed that the price had a 25% probability of falling below $122 or rising over $138. At the time, IBM’s average implied volatility score was close to 35%. The options also signaled the possibility that the share price would settle within the range of $139 at the high or $120 at the low by the end of the following week, based on how option sellers set prices before earnings.
The results report revealed that IBM exceeded its profit objective by generating $2.06 earnings per share (EPS) vs analysts’ forecasts of $1.81. However, the corporation fell short of its revenue objective, with just $20.37 billion in revenues against the estimated $20.68 billion. The firm said that it expected sales growth in 2021, but investors seemed to be focused only on the failed revenue forecast. The chart below depicts how the price started today, as well as the modified probability range depending on the market’s response to the earnings report.
The price began Friday at $120.70, the lowest it has been since before December. This response caused the stock to trade at numerous ATR multiples below the Keltner Channel average price. The price fell further when the market opened the following day, breaking through the 75% likelihood range anticipated by the previous day’s option activity. Meanwhile, option pricing the next week pushed the expected price range lower, indicating that the stock may trend downward. During the first hour of trading today, roughly 150,000 calls were exchanged against 84,000 put contracts, indicating that traders are significantly more negative on IBM than they were before.
IBM is no longer the bellwether stock that it once was, but the news of IBM’s sales shortfall may add to investors’ skepticism if other technology firms publish results that fall short of forecasts. Unless and until this occurs, IBM’s findings are unlikely to have a significant influence on broad market exchange traded funds (ETFs) such as State Street’s SPDR S&P 500 ETF Trust (SPY).Surprisingly, many investors continue to be bullish, as shown by the enormous number of calls acquired.
The Bottom Line
Option traders piled into IBM call options before of the earnings release, anticipating extremely favorable news from the business. The company’s news, however, stunned traders and investors, and IBM plummeted 7% after hours. With the next day’s option trade showing a downward move in the prediction, investors may be anticipated to have a more bearish view of the stock.
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