Immediately after the U.S. elections, the consensus was to buy the small caps and financials. The money had to come from somewhere, so Wall Street sold mega-cap tech to chase the trend then. Stocks like Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) fell, but eventually recovered. GOOGL stock even set a new all-time high. Then came earnings season.
The reaction to GOOGL earnings was brutal — shares fell 6% in four days. Luckily, GOOGL bulls stepped in and defended the stock. As a result, Alphabet Inc has all but erased the entire post-earnings dip.
I’ve always said that the short-term reaction to earnings is purely a gamble. And that the longer-term fundamentals will eventually prevail.
My interpretation of Alphabet earnings is that the Google machine is still on rails! It prints money from multiple assets that have more than a billion users; management is a proven winner; and spending on crazy ventures has abated. Alphabet now even have official structures to profit from the self-driving auto arena.
So, for the long term, I have no real worry for GOOGL stock other than the general equity market gyrations. If markets sell off, so will GOOGL. Conversely, I don’t expect shares to fall too far on their own from the company’s own actions.
GOOGL Options Play
Options are liquid enough to allow me to set in motion trades with ample buffers that I expect to be sure winners given the current environment. The trick is to find a level where GOOGL stock will be defended by fundamental investors. Then I sell risk against those levels and sit back and let time work for me.
You’ve read the statistic that most options expire worthless. So I’d want to be a seller of options since the buyers lose most often.
The Bet: Sell the GOOGL Jan 2018 $660 put. This is a bullish trade for which I collect $13 per contract to open. The 20% buffer from current price gives this trade a 95% theoretical chance of success. Selling naked puts is dangerous. Not everyone is comfortable exposing themselves to such downside risk. If GOOGL stock falls below my sold put, I am committed to owning the stock at that level. So anything below $647 per share would accrue losses if GOOGL falls 30% or so.
Since risk tolerances vary, I will offer an alternate trade with similar metrics but with a finite risk profile. The alternate version would better fit smaller accounts, too.
The Alternate: Sell the GOOGL Jan 2018 $670/$660 credit put spread. This, too, is a bullish trade for which I collect $1.25 per contract to open. The price buffer is about the same, so the theoretical chance of success is still more than 90%. If successful, this trade yields 14% on money risked. I still need GOOGL stock to stay above my sold spread to win.
Usually, I like to balance my trade by selling opposite risk. In this case, I will offer the option to do that, but I will delay entry a little in this “animal spirited” equity market.
The Hedge (Optional): Sell the GOOGL Jan 2018 $1060/$1080 credit call spread. This is a bearish trade for which I collect $1.50 per contract to open. I need GOOGL to stay below my sold strike to win. There is no $10 wide spread available yet, so I can’t make it a perfect iron condor. This trade, if successful, can yield 8% on money risked.
Usually, in perfect iron condors, my potential yield would almost double because I can only lose on one side or the other. In this case, the two sides will balance, but not perfectly. I am not required to hold these options trades through expiration. I can close any of them for partial gains or losses.
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. You can follow him on Twitter at @racernic and stocktwits at @racernic.
