Optimistic traders have bid up the share prices for Shopify Inc. (SHOP) ahead of its quarterly earnings announcement. There's no way to accurately predict the direction a stock will move after the announcement. However, a comparison of the price action between stock prices and option prices shows that if Shopify shares fall, creating a reversion back to its 20-day moving average in the first few days after earnings, downside-focused traders are in position to capture the best profits.
- Traders and investors have driven the price of Shopify shares higher heading into the announcement.
- Shopify's stock price has been closing well above its 20-day moving average.
- Put options are priced for a smaller drop and call options for a larger gain.
- The volatility-based support and resistance levels are positioned better for a move lower.
- This setup creates a greater opportunity for traders to profit if the price falls.
Option trading represents the activities of investors who want to protect their positions or speculators who want to profit from correctly forecasting unexpected moves in an underlying stock or index. That means option trading is literally a bet on market probabilities. By comparing the details of both stock and option price behavior, chart watchers can gain valuable insight, although it helps to understand the context in which this price behavior took place. The chart below depicts the price action for Shopify's share price and the setup leading into the earnings report.
The one-month trend of the stock has the shares moving strongly higher. It is notable that, over the past month, Shopify prices were around $1,120 per share at the start of February and have continually pushed higher, closing at a high of $1,452 as the announcement day draws near. The price closed in the upper extreme region depicted by the technical studies on this chart. The studies are formed with 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 moved from the lower range toward its upper extreme. This unusual price move for Shopify shares implies that investors remain very optimistic about the report ahead.
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 one to two weeks of trading on a daily chart.
In this context where the price trend for Shopify has been accelerating, chart watchers can recognize that traders and investors are expressing strong optimism going into earnings. That makes it important for chart watchers to determine whether the move is presaging investors' expectations for a favorable earnings report. One bit of evidence to support the idea that investors are expecting good news from the company report can be found in the comparison of the volatility range depicted on the chart by the purple lines and the purple box in the background. Prices have moved optimistically; they are at the top of this range.
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, this channel indicator makes for an excellent visualization tool when charting historical volatility.
Option traders recognize that Shopify shares are pushing higher and 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 Feb. 19, the Friday after the earnings report is released. The green-framed box represents the pricing that the call option sellers are offering. It implies a 75% chance that Shopify 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 the same probability if prices go lower on the announcement. One item of note is that both the red and green boxes depict a price range larger than the move that Shopify shares made in the week following the previous earnings announcement. This implies that option buyers on both sides expect a big move from this announcement.
It is important to note that trading on Friday featured over 18,000 call options traded compared to roughly 13,00 put options, demonstrating the bias that option buyers had. Right now, any liquid stock in the market typically has put options accounting for 34% of the total of all options traded. The fact that nearly 41% of the Shopify option volume is traded as put options means that traders are bit more nervous than normal about the coming earnings announcement – perhaps with good reason since the price is trading so close to the upper edge of the volatility range.
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 option pricing is so much closer to the upper line of this study than the put option pricing is to the lower boundary. This suggests that buyers could run in to eager sellers as the price approaches this line, potentially causing the price action to reverse.
These support and resistance levels show a lot less support for prices if they should begin to fall and a lot more resistance for prices if they begin to rise. As a result of this, and because of the obvious bias that option buyers have toward good news, it is possible that bad news will catch investors by surprise and could generate an unexpectedly strong move. After the previous earnings announcement, Shopify shares rose only 5% in the days following. Because of the width of the volatility range, there is a strong possibility that the price move that follows the coming earnings announcement may be larger than last time.
The effect of Shopify's earnings report, all by itself, is likely negligible to the market. However, the stock is heavily traded, and options on the stock are also actively traded. Therefore, no matter what the report says, the price action may influence the perceived value of selected stocks in the technology sector and the cloud computing industry group. With more than 50% of the S&P 500 Index (SPX) companies having reported earnings by now, and a large majority of them beating estimates, it is quite possible that investors could expect a positive surprise from Shopify. This could lift the technology sector exchange-traded funds (ETFs) such as State Street's Technology Sector Sector SPDR Fund (XLK), the Nasdaq 100-tracking Invesco QQQ Trust (QQQ), and the WisdomTree Cloud Computing Fund (WCLD)
The Bottom Line
Option traders on Shopify favored call options by a narrower-than-usual margin over put options before the company's earnings announcement. The current numbers for Shopify imply that investors are expecting good news but are nervous just the same. If the company reports unfavorable earnings or guides lower for some reason, Shopify shares could fall drastically because of the lack of support nearby in the volatility range. The volatility price range shows that call option trading has priced in the possibility for the stock going beyond current volatility ranges. However, this range has yet to constrict, leaving open the possibility for a continued upward move in prices.
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