Event: Alphabet (GOOGL) reports Q1 results tonight after the close. The options market is implying about a 5.5% one day move, or about $42 in either direction, which is cheap to the 4 qtr average of about 6.5%, but about in line with the 10 year average one day move of about 5.8%.
Sentiment: Wall Street analysts are overwhelmingly positive with 45 Buy ratings, 5 Holds and NO Sells with an avg 12 month price target of $927, or 17.5% higher than current levels. Short interest is only 1.2% of the float.
Technicals / Price Action: GOOGL is flat on the year, up nearly 15% from its 2016 lows made in February and up a whopping 50% from its 52 week lows made last April. The stock looks poised to make a run at the prior all time highs that came the day after they reported their Q4 results on February 1st.
While the market we are in today is clearly different than early February when GOOGL reported their Q4 results, it is worth noting that following those results the stock gapped up to new all time highs (was up more than 5%) before reversing to close up on the day by just 1.3%. That reversal accelerated in the days after. The point here is simple, regardless of the market, investors came to the conclusion on the morning of February 2nd that things for GOOGL might be as good as it gets for the time being.
Valuation, expected growth: GOOGL trades nearly 23x expected 2016 adjusted eps $34.50 growing at 17%, but on a GAAP basis it trades at 28.5x. Sales are expected to grow in 2016 to $72 billion, yoy growth of 19%.
Capital Return: last year the company hired a new CFO from Morgan Stanley who promptly tapped the debt markets to the tune of $5 billion and started to buy back stock for the first time in the company’s history. GOOGL has $78 billion in cash on their balance sheet, or about 15% of their $533 billion market cap. Investors would like to know more about how they plan to deploy this cash for acquisitions or cash return.
Expectations – below is a Cheat Sheet from RBC Capital’s Mark Mahaney:
Options Volatility Snapshot: Short dated options prices are well below the levels from the last two quarters, but basically in line with the one year average, while realized volatility (how much the stock has been moving) reaching it lowest levels in a year:
Options prices seem fair heading into the event given the low levels of movement in the underlying stock. It appears that at least one trader shares this view, on Monday when the stock was $785, 600 of the April 22nd weekly 760 / 810 strangle appear to be bought to open for $20.40. If this was the case the trader is playing for a move below $759.60 (put strike less the total premium) or a move above $830.40 (call strike plus the total premium), basically in line with the implied move of about $42.
My View Into the Print: I am hard pressed to think there will be any large surprises as the sequential and yoy weakness in the dollar should have been a tailwind as nearly 50% of their sales come from outside the U.S. Any concerns I have about GOOGL are less about the here and now, and less about their “other” bets and more to do with how they defend their moat in desktop and mobile search from emerging competitors like Facebook using social and short messaging platforms to disintermediate GOOGL’s core search business. For instance there is some who think FB’s plan to monetize their nearly $20 billion acquisition of WhatsApp through payments (and other search related activities that will lead to payments) is a plan to cut out Google search all together from your mobile device habits. For instance the idea that from your smartphone you could send a WhatsApp message direct to Amazon, searching for a product, and paying with pre-loaded payment info. Remember that in FB 2014 hired then President of PayPal to possibly integrate mobile payments systems in App. The risk is that Google, who now has more than 80% of search queries, could all the sudden be cut out as the middle man of tons of transactions. Maybe this is all pie in the sky sort of stuff but the only social property GOOGL has at the moment with any real growth is YouTube, and that is another area that FB is coming at hard in user generated and live streaming video, that they think they can serve a shit ton of ads on. Again this all a zero sum gain to some degree at GOOGL’s expense. And GOOGL really has NO short messaging properties like FB’s WhatsApp, Instagram or Messenger which have proven to be very sticky services that tie in well to their core offering. In my opinion Google should stop with a lot of the moonshot nonsense, stop buying back their stock and deploy that massive cash balance and make some acquisitions like SnapChat and Twitter to better compete for a demographic that FB has been focused on for some time. So again its not today or tomorrow, but at some point its my view that long FB, short GOOGL could be a great multi-year pairs trade.
Until that point though, how does one position into the event? At the risk of being repetitive, we like the idea of defined risk positioning into events of stocks back near their all time highs. This allows for investors and traders to be positioned for a breakout, while limiting risk to the downside in case the quarter itself is ugly.
So What’s the Trade?
For those looking to replace their stock or want to own Google for move to the previous highs but don’t want to leave themselves open for a big reversal from this spot near the highs, stock alternatives make sense:
In lieu of 100 shares of GOOGL ($780) Buy the April22nd weekly 775/825/875 call fly for $15
- Buy to open 1 April22nd 775 call for 23
- Sell to open 2 April22nd 825 calls at 4.40 ($8.80 total)
- Buy to open 1 April22nd 875 call for .80
Rationale – This call fly limits possible losses on an earnings move lower to just $15 (less than 2% of the underlying). It breaks even at $790 (slightly more than 1% higher) and targets a move slightly above the recent highs that cam on the last earnings report in early February. A close at 825 on tomorrow’s expiration means the $15 risked could be worth $50, a nearly 5% possible gain in the underlying while only risking 2% (so better than 2 to 1 odds). Again, the key to this trade is what’s being risked, $15 versus the implied move of $42. The only tradeoff on this trade vs stock is that a move above 825 and profits begin to trail off, but the trade isn’t a loser until $860 and the options market is telling you that a move like that is unlikely. So the range of profitability is from $790 to $860, with max gains realized at $825, and any gains in the stock between 790 and 825 will have been like buying stock for 790 while only risking $15.
But what if you’re already long GOOGL, think it has the potential for new highs but just can’t stomach a large move lower on earnings. That means your stock is a great candidate for protection.
Hedge vs 100 shares of GOOGL (780) Buy the April22nd weekly 760/710 (puts) April22nd 825 (call) put spread collar call for 7.00 debit
- Buy to open 1 April 760 put for 13.00
- Sell to open 1 April 710 put at 2.00
- Sell to open 1 April 825 call at 4.00
Rationale – This put spread collar protects GOOGL shares from 753 down to 710 (near the recent lows in the stock.) It is for those willing to get called away in their profits above 825 on a new high in the stock, that is the sacrifice, but again, 825 is outside the implied move and above the previous high. It costs $7 so that $7 is very much in play to be worthless tomorrow but ideally it becomes worthless on a move higher towards 825 where it will have cost less than 1% of the underlying to protect up to 5% of losses on a move lower towards 710 which seems like the realistic risk if a move out performs the implied move to the downside (green line is area of protection):