According to Eli Lilly and Company (LLY) reported that it missed analysts’ projections for fiscal second quarter earnings results, options traders are taking action that suggests they believe the stock price will rise in the future. This may not come as a surprise considering the stock price was up 2.5% the day after the announcement.
Eli Lilly reported Earnings per share (EPS) of $ 1.87 and revenue of $ 6.74 billion, which fell short of analysts’ expectations calling for an EPS of $ 1.89, while expectations for revenue of $ 6 .59 billion US dollars was exceeded. Prior to the announcement, investors had sold the LLY share price with a large number of Put options by doing open interest.
Options trading volumes indicate that traders have bought Calls and sell puts; However, post-earnings option trading activity shows that traders remain confident about LLY’s future stock price. This is because price action has stayed in an extreme range while options activity means traders continue to buy calls and sell puts.
The central theses
- Traders and investors bought LLY shares after the earnings announcement as the stock rose 2.5%.
- LLY’s share price continued to close above its 20-day moving average.
- Put and call options appear to be geared towards making the stock price rise.
- The volatility-based support and resistance levels allow for greater movement on the downside.
- This setup offers traders the opportunity to benefit from a reversal of the earnings-based price movement.
Options trading is a literal bet on the probabilities of the market – a bet made by traders who, on average, are better informed than most investors. The key to maximizing insight into options trading is understanding the context in which the price movement took place. The following graphic illustrates the development of the LLY share price on August 9th and illustrates the list after the profit report.
The stock’s one-month trend caused the stock price to climb above the upper extremes of the volatility range, close well above the 20-day moving average, and close on the highest extremes of the range represented by the technical studies on this chart.
These studies are formed through 20 days Keltner Canal Indicators. These represent price levels that are a multiple of the Average true range (ATR) for the share. This array helps highlight the way in which the price exceeded the upper bounds of the volatility range. This price movement of LLY stock implies that investors are extremely confident about the future stock price of LLY.
the Average True Range (ATR) has become a standard tool for displaying historical volatility over time. The typical average length of time used in the calculation is 10 to 20 time periods spanning two to four weeks of trading on a daily chart.
Chart watchers can see that traders expressed optimism about profits based on the price trend for LLY closing at the upper extremes of the volatility range. Chart watchers can also form an opinion about investor expectations by paying attention to details of options trading. Prior to the announcement, traders appeared to be expecting LLY stock to move higher after gains.
the Keltner channel display shows a series of semi-parallel lines based on a 20 day simple moving average and a top and bottom line. Since the top lines are drawn by adding a multiple of ATR to the average and the bottom lines are drawn by subtracting a multiple of ATR from the average price, this channel indicator is a great visualization tool for showing historical volatility.
Recent activity by option traders implies that they are considering LLY stocks undervalued and bought call options to bet that the stock will close within the box shown on the chart between today and August 20th of the next month Best before date for options. The box outlined in green represents the prices offered by call option sellers. This implies a 70 percent chance that LLY stock will close within that range or higher by August 20th. So sellers are only slightly optimistic. However, buyers are snapping up this price, which suggests buyers are viewing these options as undervalued. With pricing only implying a 30% chance that prices could close above that green box, it seems buyers are willing to put up with these high odds.
It is important to note that the August 9th open interest had over 65,000 call options compared to over 90,000 put options, which shows the bias of option buyers as it usually means options traders expect price movements to be down. After the profits, the volatility decreased dramatically, but the number of put options in the open interest increased. This signals a bearish mood.
For strikes on the money and one step in either direction, the call volume outweighs the put volume. The out-of-the-money put volume declines much more slowly than the out-of-the-money call volume. It should be noted, however, that the implied volatility this volume of put options is declining, suggesting that put options are still being traded in bulk, but are being sold more than they are bought.
The purple lines on the chart are generated from a 10-day Keltner Channel study that was set at four times the ATR. This measure tends to have strongly correlated regions with strong Support and resistance in the price action. These regions show up when the channel lines make a noticeable turn within the last three months.
The planes that mark the turns are given in the table below. What is remarkable about this chart is that the call and put prices are so different and there is plenty of room for a downtrend. This suggests that in the weeks following the report, option buyers have become more confident that price is moving up. Although investors and option traders expected positive development from the report, the share price moved further up than after the last earnings report.
These levels of support and resistance represent a wide range of levels of support and resistance for prices. Hence, it is possible that there could be a major move in both directions in the near future. According to the previous earnings announcement, LLY shares fell less than 1% the following day before rising the following week. Investors may expect a similar price movement in the week following this announcement. With a lot of leeway in the area of volatility, share prices could rise or fall more sharply than expected in the short term; However, the volatility area offers more headroom to support a downward move.
LLY exceeded sales expectations but missed analysts’ forecasts for earnings per share. The share price rose 2.5% the day after the announcement and stayed at the high end of the volatility range, closing well above the 20-day moving average. Options traders appear to be buying calls and selling puts, resulting in a bullish outlook. However, this activity leaves more room in the volatility range for future downward movement in the stock price.
Example of options trading
As a wager on market probabilities, unusual option activity can offer traders a glimpse into investor sentiment towards the company and illustrate what “smart money” does to high volume orders. One way to capture the bullish sentiment reflected in post-profit activity from LLY would be to open a debit call spread.
A debit call spread, a type of vertical spread, is an option strategy in which two call options with the same expiration date but different are bought and sold at the same time Exercise prices. Although the transaction incurs initial costs, this strategy is based on the assumption that the price of the stock will rise, making the call option purchased more valuable in the future. In the best case scenario, LLY’s share price would rise to or above the exercise price of the option sold. This would deliver the maximum profit while limiting the risk.
For example, to capture bullish sentiment, the purchase of the September 10 call costs $ 260 $ 12.40 and has a break-even price of $ 272.40. The $ 275 sale of the September 10 call will return $ 4.40 in credit with a break-even price of $ 279.40. After buying the $ 260 and selling the $ 275 call, the net charge on this trade is $ 8.00 or $ 800 per contract. The break-even price of the trade at expiration is $ 268 (data snapshot dated 3:59 p.m. EDT, 8/9/2021). The graphic below illustrates the setup for this particular debit call spread.
No strategy is without risk. The maximum risk on this trade is the total charge paid on the trade, or $ 800 per contract. Because this strategy sells a call option at a higher strike price than the one purchased, the potential profit is limited, as opposed to simply buying a call option itself. For this particular example, the maximum potential profit is $ 700. The potential risk return for this trade can be calculated as $ 700 / $ 800 = 87.5%.