2 Ways to Play Google Before Earnings

by Tyler Craig | April 18, 2013 7:21 am

stockoftheweek 2 Ways to Play Google Before Earnings[1]Google (NASDAQ:GOOG[2]) — the king of all things search — is set to report earnings tonight after the bell.

Since reaching an all-time high of $844, Google has quietly pulled back over the past month to $780, a 7.5% decline. The mild downturn has led to some conflicting signals across different time frames.

While the weekly chart remains firmly entrenched in an uptrend with the recent correction appearing as a garden variety pullback, the daily chart has rolled over into an outright downtrend.

GOOGweeklychart 300x224 2 Ways to Play Google Before Earnings
Click to Enlarge
A resolution of the conflict between daily bears and weekly bulls likely rests on the reaction to tonight’s earnings announcement. A gap higher will reverse the daily downtrend while reaffirming the weekly uptrend. A gap lower will validate the recent weakness on the daily chart and lead to a deeper retracement on the weekly, perhaps taking GOOG down to the trendline drawn in the accompanying chart.

GOOGdailychart 300x225 2 Ways to Play Google Before Earnings
Click to Enlarge
One of the most effective ways for gauging market expectations heading into an earnings event is to use the price of an option straddle position. Simply put, the more expensive the straddle, the larger the expected gap. Since the April monthly options expire this Friday, the lion’s share of their value is based on tonight’s announcement. Currently, the 780 straddle (long 780 call + long 780 put) is trading for $39, which is about a 5% move for GOOG. If GOOG ends up gapping more than 5% in either direction, straddle buyers will capture some type of profit. Alternatively, if GOOG gaps less than 5%, then straddle buyers will end up losing.

GOOGIVchart 300x207 2 Ways to Play Google Before Earnings
Click to Enlarge
To determine how expectations for this week’s announcement compare to prior earnings releases, we can view the implied volatility (IV) chart for GOOG options. (The blue “E” icons identify prior announcements.)

Notice how the IV is sitting at 27%, which is lower than where it was heading into almost every other announcement in the chart. The lower IV level reflects market expectations that the upcoming earnings gap will be less than prior ones. Time will tell whether the options mart is correct.

Interestingly, the outcome of the past seven announcements was a mixed bag, with neither volatility buyers nor sellers having the upper hand. The following table compares the price of a front-month straddle on the day before earnings compared to the day after earnings. Straddle buyers won three times, lost three times and essentially broke even once. While seven separate data points is too small a sample size to draw any meaningful conclusions from, the exercise at least shows the recent difficulty of determining whether to buy or sell Google options into earnings.

GOOGearningssheet 2 Ways to Play Google Before Earnings[3]

If you’re inclined to make a directional bet into the big event, though, here are two plays — one bullish and one bearish — worth consideration:

  1. Bull: Sell the April 735-730 put spread for 70 cents credit. By selling a spread that’s over $40 out-of-the-money, you position yourself to profit even if GOOG gaps down (provided it doesn’t drop by more than the options market expects).
  2. Bear: Sell the April 825-830 call spread for 75 cents credit. Like the suggested put spread, we’re selling options over $40 out-of-the-money, so even if GOOG ends up gapping higher, you still have a good probability of winning.

Since both trades involve selling options with one day remaining to expiration, they’re both definitely higher-risk, higher-reward plays. You will capture the max profit or incur a large portion of the max loss very rapidly.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

Endnotes:
  1. [Image]: http://investorplace.com/hot-topics/stock-of-the-week/
  2. GOOG: http://markets.financialcontent.com/investplace./quote?Symbol=GOOG
  3. [Image]: http://investorplace.com/wp-content/uploads/2013/04/GOOGearningssheet.png

Source URL: http://investorplace.com/2013/04/2-ways-to-play-google-before-earnings/
Short URL: http://invstplc.com/1nyE2zL