After Shopify Inc. (SHOP) reported that it had beaten analysts” expectations for its fiscal second quarter earnings results, option traders are taking actions that imply they think the share price will drift higher in the future. This may be surprising considering that the SHOP share price fell less than 1% the day after the report was announced.
SHOP reported earnings per share (EPS) of $2.24 and revenue of $1.12 billion, beating analysts’ prediction of $0.97 EPS and $1.04 billion in revenue. Notably, the company updated its 2021 outlook but did not provide specific guidance for the third quarter and beyond. Prior to the announcement, investors had kept the share price of Shopify range bound, with a large number of 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 still confident in SHOP’s share price going forward. That’s because, while the price action moderately fell below the pre-earnings share price, it seems to have found support, staying just above the 20-day moving average, while option activity implies that traders continue to buy calls and sell puts.
The share price of SHOP fell closer to but has remained just above its 20-day moving average.
Put and call option activity appears to be positioned for the price to rise.
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 share price movement.
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 SHOP’ 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 after the announcement. The price fell to the middle 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 upper region of this range to the middle bounds. This price move from SHOP shares implies that investors have assessed SHOP 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 SHOP 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 Shopify 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 SHOP shares undervalued and have bought call 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 green-framed box represents the pricing that the call option sellers are offering. It implies a 69% chance that SHOP shares will close inside this range or higher by Aug. 20. So sellers are only mildly bullish. However, buyers are snapping up this pricing, suggesting that buyers consider these options underpriced. Since the pricing implies only a 31% chance that prices could close above this green 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 120,000 call options compared to over 93,000 puts, demonstrating the bias that option buyers had, as traders favored calls over puts. This normally implies that option traders expect upwards price action. After earnings, the volatility has decreased dramatically, but the number of call options in the open interest increase and the number of put options has been declining. This signals that call options are being bought, creating a bullish sentiment.
For the strikes at the money and one step either direction, the call volume far outweighs the put volume. Out-of-the-money call option volumes decline at a slower rate than out-of-the-money put volume, which would signify that more traders believe that SHOP share prices will rise than those who believe share prices will fall.
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 in either direction. 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 less 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, SHOP shares fell 4.3% in the day following before falling the following week. Investors may be expecting a different 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 room in the volatility range to support a move in either direction.
Shopify beat analysts’ expectations for both EPS and revenue. The company updated its 2021 outlook but did not provide specific guidance, causing some traders to sell their shares, sending the share price to the middle bound of the volatility range on the charts. Option traders appear to be buying calls and selling puts, which reflects a bullish outlook. This activity provides an equal amount of room in the volatility range for a move up or down in the share price in the future.