After The Procter & Gamble Company (PG) disclosed that its fiscal fourth quarter profit results above analysts’ expectations, option traders are taking measures that indicate they believe the share price will rise in the future. This may come as a surprise given that the stock declined less than 1% the day following the news.
PG reported earnings per share (EPS) of $1.13 and sales of $18.95 billion, above analysts’ forecasts of $1.08 and $18.41 billion, respectively. Prior to the announcement, investors had bought up PG’s share price to an inflated level, with a visibly high amount of call options in open interest.
Option trading volumes show that traders were buying calls and selling puts; yet, option activity after earnings indicates that traders are still bullish on PG’s share price in the future. This is because price action has stayed above the 20-day moving average, indicating that traders are continuing to purchase calls and sell options.
- Following the results report, traders and investors sold PG shares, causing the price to fall less than 1%.
- PG’s stock price has remained above its 20-day moving average.
- Put and call option activity looks to be positioned for an increase in the share price.
- Support and resistance levels depending on volatility allow for a bigger move to the negative.
- This setup allows traders to benefit from a reversal in the earnings-based price trend.
Option trading is simply a 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 PG’s share price as of Aug. 6, showing the setup after the earnings announcement.
The stock’s one-month trend saw it push the high limits of the volatility range and bounce off the 20-day moving average before finishing in the upper third 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 emphasize how the price fell from the top third of the range to the middle boundaries before climbing again to the upper third. This price movement in PG shares suggests that investors remain confident in PG’s share price in the future.
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 PG closing above its 20-day moving average, chartists may see that traders were optimistic coming 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 PG shares to rise following results.
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.
Options traders’ recent activity suggests that they believe PG 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 PG 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 33% probability that prices would close above the red box, it suggests that purchasers are ready to risk the long odds.
It is worth noting that open interest on August 6 contained approximately 262,000 call options vs over 148,000 puts, illustrating option buyers’ bias, since over 60% of the options were calls. This usually means that option traders anticipate an increase in price fluctuation. The volatility has lessened considerably after results, but the quantity of call options in open interest has climbed, and the put/call ratio is decreasing. This indicates a positive attitude.
The call volume outnumbers the put volume for strikes at the money and one step either way. Out-of-the-money put volume is declining at a considerably slower pace than out-of-the-money call volume, indicating that more traders expect that PG share prices will fall than increase. However, the implied volatility of this put option volume is also decreasing, suggesting that put options, although being traded in high quantities, are being sold more than acquired.
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. To catch the optimistic mood indicated in PG option traders’ post-earnings activity, establish a debit call spread.
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 would climb somewhat, making the acquired call option more valuable in the future. The best-case scenario would be for PG’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 present bullish mood, purchase the Sept. 10 $140 call for $3.80, with a breakeven price of $143.80. Selling the September 10 $145 will result in a $0.84 credit, with a breakeven price of $145.84. The net deficit for this deal is $2.96, or $296 per contract, after purchasing the $140 and selling the $145. The trade’s breakeven point at expiry is $142.96. (data snapshot as of 3:59 EDT, Aug. 6, 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 $296 per contract, is the maximum risk on this trade. In comparison to purchasing a naked call option, the potential profit is limited since this method sells a call option with a higher strike than the one acquired. The greatest possible profit in this case is $204. This trade’s potential return on risk is computed as $204 / $296 = 69%.
Procter & Gamble exceeded analysts’ forecasts for earnings per share and sales. The stock dropped less than 1% the day following the announcement and has since maintained in the top part of the volatility range, closing 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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