Thursday, April 15, 2010

Google (GOOG) - Earnings Preview with Price Patterns

GOOG is trading 590.00 (or about there) with earnings today AMC. The LIVEVOL™ Pro Summary is below.

GOOG habitually has earnings the day of expiration (actually Thursday evening of expo week). This makes their front month options pure earnings vol. A very exciting/dangerous/lucrative opportunity. One other uniqueness about GOOG recently makes it a "must write about" topic.

For the last three earnings cycles, it has pinned within $0.25 of a strike. That means, hypothetically, if it this continues, all someone has to do is guess the price (in $10 increments) where GOOG is going.

Here are the last three closing prices the day after earnings:



Note last time, within $0.01 of a strike. So the question is, where are the options pricing the most likely outcome and how can money be made if you guess right without being naked long or naked short options. GOOG also has gone up to a strike (or near a strike) pre-earnings day and then dropped the $7 or so to hit the lower strike and pin.

Here's one way: Use butterflies. A buttefly is net even options (#long = #short) so it has a limited upside and downside. A butterfly is used if you have a strong conviction that a stock will stick to a specific price - how convenient for GOOG.

All the calculations are based on this snap of the Options Tab (and mid-market values):

Below you can find the payouts (as of this posting; click to enlarge) if you expect GOOG to pin at 580 (bearish), 590 (stay here), 600 (bullish). Note a butterfly is long the wings (upside and downside) then short twice the middle.

Graphically - the 580-590-600 (buy 1 580 call, sell 2 590 calls, but 1 600 call) looks like below:

You can see the max gain is always at the short strike. I like to think of things in 50 lots, so for this particular one, a 50 lot has a max gain of $45,000 and a max loss of $5,000.

Of course, GOOG doesn't have to pin - it can go anywhere, and it certainly doesn;t have to be 580,590 or 600 (the three butterflies included above). There's no reason it can't move $70 or more. Since the payoff for the 590 butterfly is the highest, that means it's the least likely of the three considered.

A few cycles ago I tried this (couldn't resist) and got a 10:1 ratio to put it on. I was $10 off though (I had the $440 butterfly on the 7-19-2009 cycle and it closed $430)... Instead of turning $10k in $100k, I turned $10k into $4k. The only reason it didn't all disappear was a bit of day trading to try to recover.

Finally, you can see the GOOG skew today and how it looked the day after earnings in January.

I really mean it on this one: This is trade analysis, not a recommendation! A fair evaluation of this strategy is that it's HIGHLY unlikely to actually pay near max gain - thus the ridiculously high ratios.

Also, don't let me limit your strategies - this is just one view of an enormous number of ways to play this one day swing. I haven't directly discussed vol - and vol is in play in a major way right now.

One note of caution, be careful being short more contracts than long in GOOG, it can move $100 or more. Having said that, being short vol is not necessarily a bad move and you can do that being contract neutral pretty easily...

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