After PayPal Holdings, Inc. (PYPL) reported that it had missed revenue expectations for its second quarter earnings results, option traders are taking actions that imply they think the share price will drift lower in the future. This may not be surprising considering that the PYPL share price fell 6.2% the day after the report was announced.
PayPal reported an earnings per share (EPS) of $1.15 and revenues of $6.24 billion, beating analysts’ expectation of $1.12 in EPS but missing revenue expectations of $6.27 billion. Notably, the company provided lower-than-expected guidance for the third quarter. Prior to the announcement, investors had kept the share price of PayPal range bound, with a sizable number of out-of-the-money call options in the open interest.
Option trading volumes indicated that traders had been buying calls and selling puts; however, option activity after earnings suggest that traders are not confident in PYPL’s share price going forward. That’s because the price action fell to the bottom of the volatility range, well below its 20-day moving average, while option activity implies that traders are both buying puts and selling calls.
The share price of PYPL closed well below its 20-day moving average.
Put and call option activity appears to be positioned for the price to continue to decline.
The volatility-based support and resistance levels allow for a stronger move upward than downward.
This setup creates an opportunity for traders to profit from a reversal in the earnings-based share price decline.
Option trading is literally a bet on the probabilities of the market–a bet made by traders that are, on average, better informed than most investors. The key to maximizing insight into option trading activity is to understand the context in which the price movement took place. The chart below illustrates the price action for PYPL’s share price as of Aug. 6, illustrating the setup after the earnings report.
The one-month trend of the stock saw the share price falling from its all-time high in late July to a relatively average range, before falling 6.2% the day after the announcement. The price fell to the lower extremes before gradually rising to a below average range, depicted by the technical studies on this chart.
These studies are formed by 20-day Keltner Channel indicators. These depict price levels that represent a multiple of the Average True Range (ATR) for the stock. This array helps to highlight the way the price has fallen from the middle portion of this range to the lower bounds. This price move from PYPL shares implies that investors have assessed PYPL value to a lower level going forward.
The Average True Range (ATR) has become a standard tool for depicting historical volatility over time. The typical average length of time used in its calculation is 10 to 20 time periods, which includes two to four weeks of trading on a daily chart.
Chart watchers can recognize that traders were expressing optimism going into earnings, based on the price trend for PYPL closing above its 20-day moving average. Chart watchers can also form an opinion of investor expectations by paying attention to option trading details. Prior to the announcement, traders appeared to be expecting that PayPal shares would move upwards after earnings.
The Keltner Channel indicator displays a set of semi-parallel lines based on a 20-day simple moving average and an upper and lower line. Because the upper lines are drawn 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, then this channel indicator makes for an excellent visualization tool when charting historical volatility.
The recent activity of option traders implies that they consider PYPL shares overvalued and have bought put options as a bet that the stock will close within the box depicted in the chart between today and Aug. 20, the next monthly expiration date for options. The red-framed box represents the pricing that the put option sellers are offering. It implies a 68% chance that PYPL shares will close inside this range or lower by Aug. 20. So sellers are only mildly bearish. However, buyers are snapping up this pricing, suggesting that buyers consider these options underpriced. Since the pricing implies only a 32% chance that prices could close below this red box, it appears that buyers are willing to take those long odds.
It is important to note that open interest on Aug. 6 featured over 363,000 call options compared to roughly 360,000 put options, demonstrating the bias that option buyers had, as traders favored calls over puts by a narrow margin. This normally implies that option traders expect upwards price movement. After earnings, the volatility has decreased dramatically, but the number of call options in the open interest increased, and the number of put options remained elevated. This signals that call options are being sold, rather than bought, creating a bearish sentiment.
For the strikes at the money and one step either direction, the put volume far outweighs the call volume. Out-of-the-money call option volume declines at a slightly faster rate than out-of-the-money put volume, which would signify that more traders believe that PYPL share prices will fall than those who believe share prices will rise. However, it should be noted that the implied volatility of this call option volume is also declining, indicating that call options, while being traded in large volumes, are being sold more than being bought.
The purple lines on the chart are generated by a 10-day Keltner Channel study set at four times the ATR. This measure tends to create highly correlated regions of strong support and resistance in the price action. These regions show up when the channel lines make a noticeable turn within the previous three months.
The levels that the turns mark are annotated in the chart below. What is notable in this chart is that the call and put pricing are in such disparity with plenty of space to run higher. This suggests that option buyers have a stronger conviction of the price moving lower in the weeks following the report. Although investors and option traders expected positive movement from the report, the share price moved further to the downside than it did after the last earnings report.
These support and resistance levels show a large range of support and resistance for prices. As a result, it is possible that there could be a large move in either direction in the near future. After the previous earnings announcement, PYPL shares rose 1.87% in the day following before falling the following week. Investors may be expecting the same kind of move in price in the week after this announcement. With lots of room in the volatility range, share prices could rise or fall more than expected in the near term; however, there is more room in the volatility range to support a move to the upside.
PayPal beat analysts’ expectations for EPS but missed on revenue predictions. The company provided lower-than-expected guidance for the third quarter, causing some traders and investors to lose faith with the company, sending the share price to the lower bound of the volatility range on the charts before slightly rising upwards. Option traders appear to be selling calls and buying puts, which reflects a bearish sentiment. This activity, however, does provide more room in the volatility range for an upward move in the share price in the future.