Alphabet Inc (GOOG, GOOGL) stock has not been immune from 2016’s ugly January, with shares off more than 5% after a sharp 40% rise in 2015.
Fundamentally, Alphabet has competent management that has proven it can execute. The company has shed the reputation of not being focused, in party by switching its corporate name and structure to put Google inside of Alphabet Inc. The company rebranded itself to help investors separate the cash cow search engine from the extraordinary ventures. Google also owns the search arena, and it looks like it will be one of the early leaders in the self-driving auto industry.
GOOGL’s future looks rosy, with no obvious serious fundamental pitfalls to be found.
Simply put: Unless the broader markets crash, I see more upside potential than downside risk for Google stock.
Technically, GOOGL broke down from $745 on Jan. 7 but emphatically bounced off the $700 area on a closing basis. It is important to note that Google stock has since faded this $745 level from which it recently broke down, making it an important short-term pivot point.
Earnings (out Feb. 1) will determine if Google stock will retake the level into new all-time highs or revert lower to test the recent support levels.
I want to use this pivot point to bet that GOOGL has more upside potential than downside risk. But I am not about to risk thousands of dollars to do that. Short-term, the Google stock price reaction to earnings looks like a coin flip — I don’t know what the company will say or how markets will react.
But I can tell you there’s no fundamental issue specific to GOOG that would cause it to fall far on its own.
Click to Enlarge Today, let’s use options to minimize risk while maximizing gains. Options are time-sensitive, so I want to set enough time on my trade to better manage the risk. I will implement this strategy in two parts.
2 Trades on Google Stock (GOOGL)
Trade #1: I sell the GOOGL Apr $560 put. For this I collect $3.20 per contract. This opens the downside risk if Google stock falls. If I get assigned GOOGL stock, my breakeven point would then be $556.80 per share. For that to happen, GOOGL would need to fall another 23% from current levels. I can close this risk at any point between now and the expiration date.
Trade #2: I buy GOOGL Feb $742.50/$745 call spread. For this I pay $1.10 per contract. I only need GOOGL to rally 2% before being in-the-money. For this combination trade to be 100% successful, I need Google stock to rise past my long call spread by February expiration. I stand to more than double my premiums; however, since I am financing this by selling puts, any profits are pure profits.
Selling naked puts is risky. I only do it when I am willing to buy the stock at the strike price sold. In this case, I don’t mind owning Google stock 23% cheaper than where it’s trading now. If I buy 100 shares of GOOGL outright, I would risk $73,000 at current prices. Any drop in price would result in immediate loss of capital. These elevated volatility levels have resulted in high call premiums, so buying naked calls is also too risky for an earnings trade.
I can modify Trade #1 so I don’t carry open-ended risk. Instead of selling the puts naked, I can substitute and sell the GOOGL Apr $625/$620 credit put spread. For this I collect 80 cents per contract. This limits my exposure to the width of the credit spread less the premium I collect.
China and the oil sector continue to heavily influence the U.S. market price moves. This adds risk to betting long into GOOGL earnings. Also, consensus among many technical experts is that markets are likely to fall another 10%. If so, Google stock is likely to lose its support and fall in sympathy.
The success of my trade depends heavily on the assumption that the macro health of the economy is on track and that the Federal Reserve won’t add to the risk by raising interest rates too fast. Into this uncertainties, I believe GOOGL shows promise as long as the macro assumptions continue to hold as is.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.
