Investors of The Wendy’s Company (WEN) have kept the share prices range bound ahead of the company’s fiscal second quarter earnings announcement. At first glance, it appears option traders are positioned for a positive move, as the number of call options is rising in the open interest. The unusual option activity could create a strong downward trend in the price action if WEN delivers a negative earnings surprise.

Call option numbers are growing in the open interest for WEN, and option premiums are unusually high right now. Trading volumes indicate that traders have been buying calls and selling puts in anticipation of a favorable earnings report. If these bets were to unwind, it could create unexpected downward pressure on the share price of WEN.

Correctly predicting the direction a stock will move after earnings is challenging. However, a juxtaposition between the stock’s option activity and price action shows that, if WEN delivers a negative report, the company’s share price could tumble, moving further below its 20-day moving average after the announcement. This could happen because options are priced for an upwards move, but unforeseen poor news could catch traders by surprise and create a rapid fall in share price.

Traders and investors have kept the share price range bound ahead of the earnings report.
The share price has recently closed below its 20-day moving average.
Call and put pricing is predicting a stronger move to the upside.
The volatility-based support and resistance levels allow for a stronger move to the upside.
This setup creates an opportunity for traders to profit from an unexpected earnings result.

A comparison between the details of both stock price and option behavior can grant chart watchers valuable insight; however, it is necessary to understand the context in which this price behavior took place. The chart below depicts the price action for the WEN share price as of Monday, Aug. 9. This created the setup leading into the earnings report.

Over the past month, the trend for WEN stock has the share price rising above and falling below the 20-day moving average. In this time period, it’s notable that the lowest WEN share price was roughly $21 in mid-July, whereas the highest share price was over $23 in late July. The price closed in the middle region depicted by the technical studies on this chart.

The 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 below the 20-day moving average in the week before earnings. This price move from WEN shares implies that investors’ confidence is fading as the earnings report approaches.

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.

In this context where the price trend for WEN has recently fallen below its 20-day moving average, chart watchers can recognize that traders and investors are expressing growing concern going into earnings. It’s notable that, in the week before earnings, WEN’s share price broke its recent trend and fell below the 20-day moving average. That makes it important for chart watchers to determine whether the move is reflecting investors’ expectations for favorable earnings or not.

Option trading details can provide chart watchers with additional context to help them form an opinion about investor expectations. Recently, option traders are favoring calls over puts by a noticeable margin. On Monday, there were nearly 3,000 calls traded opposed to less than 700 puts. Normally, this volume indicates that traders are feeling bearish toward the earnings report.

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.

Option traders recognize that WEN shares have broken their trend and fallen below the moving average, and they have priced their options as a bet that the stock will close within one of the two boxes depicted in the chart between today and Aug. 13, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 40% probability that WEN shares will close inside this range by the end of the week if prices go higher. The red box represents the pricing for put options with a 33% chance if prices go lower on the announcement.

It is necessary to note that the open interest featured nearly 64,000 calls compared to over 45,000 puts, demonstrating the bias that option buyers had, as traders favored calls over puts. It is notable that nearly 3,000 calls and less than 700 puts were traded on Monday, skewing the open interest numbers even further in favor of call options. However, because the call box and put box are relatively equal in size, it tells us that the growing percentage of call options has only mildly skewed expectations higher. A far more complacent outlook is implied.

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 a close range with plenty of space to run either way, but with slightly more room to the upside. This suggests that option buyers don’t have a strong conviction about how the company will report, even though recent call volumes outweigh put volume. Although investors and option traders do not expect it, a surprising report would push prices dramatically higher or lower.

These support and resistance levels show a large range of support and resistance for prices. As a result, it is possible that any news, surprisingly bad or good, will catch investors by surprise and could generate an unusually large move. After the previous earnings announcement, WEN shares rose less than 1% the day after earnings and continued to rise the following week. Investors may be expecting a larger positive move in the price after this announcement. With plenty of room in the volatility range, share prices could rise or fall more than expected.

Wendy’s isn’t the largest stock by market cap, so its earnings likely won’t have a direct impact on indexes. No matter what the report says, it could have an impact on stocks in the restaurant industry. A positive report could lift other stocks in the sector such as Wingstop Inc. (WING), Shake Shack Inc. (SHAK), or Jack in the Box Inc. (JACK). It could also affect exchange traded funds (ETFs) such as the iShares Core S&P Mid-Cap ETF (IJH) or the AdvisorShares Restaurant ETF (EATZ).


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