Name That Trade – $GOOGL Eyes

by Dan April 23, 2015 12:00 pm • Commentary

Yesterday I highlighted some call buying in Google C Class Shares, when the stock was:

$538 there was a buyer of out of the money calls in May and June.  A buyer paid 3.70 for 1800 of the May 575 calls to open and paid 5.10 for 1800 of the June 585 calls.  While the contract sizes are not huge, the premium is fairly meaty given how far out of the money both call strikes are.

For May, the trade cost $666,000 in premium and breaks even at $578.70 on May expiration, up 7%, almost 2x the implied move.

As for the June, the trade cost a little more than $1 million and breaks-even at $590.70, up about 10%

The company is scheduled to report Q1 results tonight after the close, and the implied move in the options market is about 4% which is basically in line with the 4 qtr avg.

Last night on CNBC’s Fast Money program we were discussing Facebook’s (FB) results, which by most accounts were impressive (despite a slight revenue miss) but I suggested that I preferred owning Google (GOOGL) to FB. Watch here:

I was, and remain a bit more skeptical than the other panelists who suggested buying the after-market weakness, which from a trading perspective happened to be the right thing to do (FB was down $2 after hours and was green at points this morning).

Here is the main problem I have with FB as a stock, it has two thirds the market cap of Google (GOOGL) and less than a quarter of its trailing sales.  Right I get it, FB sales are growing far faster than GOOGL (expected 37% vs 16%) but GOOGL’s 16% expected sales growth on $51 billion in trailing sales is a lot more impressive than FB’s 37% expected growth on $12 billion. I also get that it appears that FB has done a very nice job of acquiring mobile properties like WhasApp and Instagram that have yet to be monetized (meaning extracting money from its free users).  The main reason that I am skeptical is that in the long term I am just not sure how many ads can be jammed in-app on a smartphone before it becomes a massive nuisance for users.  So I am just not sure traditional monetization is going to work on mobile messaging apps.  If we were playing “would you rather”, for the longer term, I’d stick with GOOGL as search remains the killer app on-the-line, and they remain dominant.

As I write FB is down 1.5% (kind of a rounding error), as active user growth, revenues from mobile ads and the dramatic acceleration in videos on the sites are enough to offset fx headwinds and increased spending.  To be fair, FB is doing exactly what they should be doing, investing in the future, but I guess I remain a bit more skeptical about valuation, as I mentioned yesterday in my note:

the stock is priced for perfection and I think the fact that the entire investment community seems so comfortable assigning a $235 billion market value (one third of Apple’s, who has more than 10x their trailing sales, but half their margins… kind of apples to oranges, but you get the point) seems a bit crazy to me.

Back to GOOGL, valuation is very fairly reasonable at 19x expected growth eps growth of 11% in 2015.  I suspect the video trends at FB are likely equally beneficial to Google’s YouTube property. From a technical perspective, the stock is at an interesting spot, with what looks like an impending Golden Cross (circled), where the 50 day moving average looks poised to cross above the 200 day moving average, suggesting the potential for a short term move higher:

GOOGL 6 month chart from Bloomberg
GOOGL 6 month chart from Bloomberg

But with that Golden Cross technically, if there are no fireworks in the report and it comes in fairly inline with expectations there’s a decent likelihood of the stock going right to where those moving averages are converging, right round $555. This is also roughly the midpoint in the recent range in the stock between the recent lows around $530 and the recent highs around $580. If you drew a bell curve of possible distributions of where the stock will be tomorrow morning you’d have a huge spike right at $555 and steeply declining as you moved away from that strike. That’s not to say the stock doesn’t move big. It’s obviously dependent on the report, but from a math perspective 555 is much more likely than 585 or 535 (as it always is, but alot more likely in this case from a technical perspective)

And the options market seems to agree (not to mention the stock market as the stock is hovering near that level into the report) as implied vol levels are low into this earnings compared to recent ones.

So how does one play for this? Well, this needs to be a strategy that is employed consistently in order for it to work best. As a one off it’s simply rolling dice with the odds slightly in your favor, there’s still a big probability that you lose. But over time if you did this trade with this sort of set-up, you’d make money:

Hypothetical Trade: Buy the GOOGL ($555) May 525/555/585 call fly for 9.00

– Buy 1 May 525 call for 33.50

– Sell 2 May 555 calls at 14.50 (29 total)

– Buy 1 May 585 call for 4.50

Break-evens on May expiration – Losses of up to 9 below $534 and above $576 with total loss of 9 below 525 or above 585. Gains of up to 21 above 534 and below 576 with max gain of 21 at 555.

Rationale – This is a defined risk range trade, fading the predicted earnings move. This is based on math and probability and not anything fundamentally related to what earnings will be. Over time as part of a process this strategy works. As a one off, it has slightly higher odds of working than not. But the entire $9 is at risk and could be mostly gone tomorrow on a big move outside the defined range.