Lowe's (LOW) Option Traders Wary
Traders have pushed the share prices in an upward trend for Lowe’s Companies, Inc. (LOW) ahead of its quarterly earnings announcement. There’s no way to accurately predict the direction a stock will move after an earnings announcement. However, a comparison of the price action between stock prices and option prices shows that if Lowe’s shares drop, diverging away from its 20-day moving average in the first few days after the announcement, downward-focused traders are in a position to capture the best profits.
- Traders and investors have driven the price of Lowe’s shares higher heading into the announcement.
- The price has been closing near its 20-day moving average.
- Put options are better priced for a drop than call options are for a gain.
- The volatility-based support is farther away than the resistance level.
- This setup creates an opportunity for put option traders to profit from a negative result.
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 Lowe’s share price and the setup leading into the earnings report.
The one-month trend of the stock has the shares remaining in a medium range with a slight upward trend. It is notable that over the past month Lowe’s fell to $163 per share the beginning of February, with only a slight drift higher as the announcement day draws near. The price closed in the middle 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 back to its average range and held in that range. This price move for Lowe’s shares implies that investors are wary for the upcoming report.
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 Lowe’s has been holding in a middle range, chart watchers can recognize that traders and investors are expressing uncertainty going into earnings. That makes it important for chart watchers to determine whether the move is reflecting investors’ expectations for a favorable earnings report or not.
Option trading details can provide additional information to help chart watchers form an opinion about investor expectations. Option traders are favoring calls over puts, but only slightly. This suggests that traders are worried about less than favorable news from the company report. Supporting evidence can also be found in the comparison of the volatility range depicted on the chart by the purple lines and the purple box in the background.
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 Lowe’s shares are average 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. 26, 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 74% chance that Lowe’s 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 similar probability if prices go lower on the announcement.
It is important to note that trading on Friday featured over 8,000 call options traded compared to roughly 5,000 put options, demonstrating the bias that option buyers had. Over 40% of the trades were put options, which implies that option traders are pessimistic.
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 is pushing toward the upper edge of the purple box. However, the put option range is smaller in size compared to the call option range, suggesting that investors aren’t expecting a big drop but nonetheless want to protect themselves from an unfavorable report.
These support and resistance levels show a larger range in front of support than resistance for prices. As a result of this, it is possible that any bad news will catch investors by surprise and could generate an unusually large move. After the previous earnings announcement, Lowe’s shares rose by only 5% in the days following. Investors may be expecting the same kind of small move in price after this announcement. With lots of room in the volatility range, share prices could fall more than expected.
The effect of Lowe’s earnings report is somewhat influential to the market because of the company’s connection to the housing market. Lowe’s shares typically make 5% moves after earnings, and that can be big enough to be noticeable to other stocks in the sector – especially when combined with the company’s chief competitor, The Home Depot, Inc. (HD), which reports at the same time this quarter. No matter what the Lowe’s report says, it will likely have a significant impact on stocks in the consumer discretionary sector.
Now that more than 70% of the S&P 500 companies have reported earnings so far this season and a large majority have beaten estimates, investors will expect the same from Lowe’s. Anything less would be a shock. A positive report could lift other stocks in the sector such as Home Depot, The Walt Disney Company (DIS), or even Amazon.com, Inc. (AMZN). It would also affect exchange-traded funds (ETFs) such as State Street’s Consumer Discretionary Select Sector SPDR Fund (XLY) and potentially State Street’s SPDR S&P 500 ETF Trust (SPY).
The Bottom Line
Option traders on Lowe’s are favoring call options but only by a slim margin over put options before the company’s earnings announcement. Investors appear to be nervous about what the report might bring even though they’ve been trading shares in a mildly upward trend. If a bad report does materialize, Lowe’s shares could drop significantly, more than their typical 5% move. The volatility price range size is enough to exceed the put pricing, allowing for a large move lower over the following week.
Source: Read Full Article