Alphabet Soup – GOOGL

by riskreversal October 27, 2016 1:02 pm • Trade Ideas

Earlier we highlighted the implied move in the options market (along with a few other fun facts) for Alpabet’s (GOOGL) Q3 results due out after the close.

The options market is predicting about a 5% move in either direction for GOOGL (4qtr avg one day post earnings move has been about 4%), or about $30 billion in market cap.

Investors can justify growth at a reasonable price for GOOGL. It trades 20x expected 2017 eps growth of 18%, which would be the highest growth rate since 2011, on expected accelerating sales growth of 20%.

From a valuation and technical perspective, investors are likely to be a tad more patient with GOOGL as the stock is up about 6% on the year and 25% its 52 week lows made in late June to its new all time highs made just this week. The stock should find healthy technical support near its April earnings gap level of $780 and its July earnings gap level near $760:

GOOGL 1yr chart from Bloomberg
GOOGL 1yr chart from Bloomberg

With that in mind we want to look at some options overlays, alternatives and directional trade ideas in the options market.

First, for those looking to own GOOGL here (and especially for those long the stock from lower) it makes sense to define risk so that a pullback from the highs doesn’t have you trapped. To do that we should use both the implied move and the charts to determine strikes. The implied move is about $40 in either direction. That seems awfully close on the upside to sell a call (the 860 strike) so we’ll want to go higher than that in case GOOGL pulls a MSFT and gaps to new all time highs. On the downside we can target that $780/$760 support range identified earlier.

So what’s the trade: It’s not really in our DNA to play a stock like this for continued gains into a potentially volatile event like earnings. But where we may be able to add value is offering a protective overlay for nervous longs, long stock alternatives for those looking to book some gains but replicate some prior long exposure and defined risk contrarian short bet:

Hedge:

For long holders

vs 100 shares of existing GOOGL shares (820) Sell 1 Dec 875 call and buy 1 Dec 795/755 put spread for 1.50
  • Sell 1 Dec 875 call at 8.50
  • Buy 1 Dec 795 put for 18
  • Sell 1 Dec 755 call at 8

Rationale – This sells a call above the implied move on the event (about 860 implied on a move upwards) but of course is out in December so this is only for those willing to be called away in the stock at the 875 level (you of course can cover the overlay on a move towards that level for a loss to keep the shares. On a breakdown lower however, you gain $40 or protection below 795, down to the 200 day moving average at 755.

What about those that would like to be long, but with defined risk?

Or

Long Stock Alternative:

If I were to express a brand new bullish view into tonight’s print I would risk what I am willing to lose as the event has the strong potential to be fairly binary.  We are not huge fans of long premium directional bets into events like earnings as you need to get a lot of things right to merely break-even, first and foremost direction, and then magnitude of the move.

in lieu of 100 shares of GOOGL (820) Buy the Nov 825/875/925 call fly for 12.00
  • Buy 1 Nov 825 calls for 23
  • Sell 2 Nov 875 calls at 6.25 (12.50 total)
  • Buy 1 Nov 925 call for 1.50

Rationale – This risks 12 (much less than the implied move) with the possibility to make up to 38 on a move to 875 on November expiration. The break-even on the trade is 837, so even on a move simply in line with the implied it could be a double on Nov expiration. It has a little room higher that that implied move and of course above 875 profits begin to trail off but it’s not a loser until 913, which would be a substantial move and very unlikely  about a 7% chance).

Or

Defined Risk Bearish:

in lieu of 100 shares short GOOGL ($819), buy Oct28th 800 / 750 put spread for $10.50
  • Buy to open 1 Oct28th 800 put for 11.50
  • Sell to open 1 Oct28th 750 put at 1

Break-Even on Oct28th close (tomo):

Profits: up to 39.50 between 789.50 and 750, with max gain of 39.50 at 750 (down 8.4%)

Losses: up to 10.50 between 800 & 789.50 and max loss of 10.50 at 800 or higher.

Rationale: Just like the caveat with the stock alternative, the same proves here, this is nothing other than a direction punt, with worse adds than a coin flip, but much prefer a defined risk contrarian short in a stock like GOOGL (1o year avg post earnings move has been about 5.5%) into an event than a naked short. Risking what you are willing to lose with a greater likelihood of a loss than a gain.