Leap into Google with Option Call Spreads

Let's face it: Google (GOOG) owns the internet search space. How many times have you heard people say "Yahoo it" (YHOO) or "MSN it" (MSFT)? Well if you have it probably isn't too often. I often find myself saying "Google it" when referring to searching the web.

Google has held up well through this economic downturn, and I believe as the economy gets healthier, bids for clicks will increase, and as a result Google's share price should as well. However clicks are not the only way Google generates money anymore. The growth of Google Checkout is also generating a steady stream of income (a good example of Economies of Scope). Recently an analyst upgraded the price target on GOOG to $600 a share, with some analysts even claiming it to be as high as $750 in 1 year. A recent article states that Google's Android mobile OS is expected to grow at 900% in 2009 beating expected growth for both Apple (AAPL) and Blackberry (RIMM).

In my opinion Google is a solid company going forward; they were able to add $2 billion in cash over the last quarter which is a big plus, especially in this economy. There are several other factors why I think Google is a great company, but this is not the intention of this article.

So on with the strategy: a Google bull call spread: (prices as of close Tuesday May 12, 2009- prices should be adjusted daily).

I checked both the Google Leap 10 and 11 call options. I believe $600 is a feasible share price for Google in 18 months so I'll use that as my upper limit for the leap 11, and I'll use $530 for the upper limit for the Leap 10.

Strategy # 1: Buy the GOOG Leap 10 $400 Call and sell the Leap 10 $530 Call. To open this strategy would cost roughly $3,400. However if Google is above $530 come January 2010 expiration this strategy would net a profit of $9,600 or 282% gain. To break even Google would need to be at $434 come January expiration.

Strategy #2: Buy the GOOG Leap 11 $400 Call and sell the Leap 11 $600 Call. To open this strategy it would cost roughly $6,000, and this strategy would net a profit of $14,000 or 333% if Google closed above $600 at expiration in January 2011.

I have implemented the first part of strategy two. However, I am bullish on Google; therefore, I'd like to complete the call spread at a later date, when Google is 10%-15% higher. After all, I do have over 600 days to sell the call.

According to the current Delta value if GOOG were 10%-15% higher, it would yield an additional $9 to $13 for the $600 contract. As GOOG's share price increases, so will the Delta value (assuming Google to increase sooner rather than later), therefore the premium on the $600 call would be even higher than the calculated value.

I am bullish on Google, therefore the way I look at it is:

For strategy 1: for every spread position opened I would have 8.5 shares of Google (let's call it 9.) If Google gets to $530 I would have made a profit of $1,170 or 34.4%. Google needs to get to $438 in order for this spread strategy to make $58 more than owning 9 shares of Google common stock.

For strategy 2: for every spread position opened I would have 15 shares of Google. If Google gets to $600 I would have made a profit of $3,000 or 50%. Google needs to get to $471 in order to make $35 more than owning 15 shares of Google's common stock.

However, in both cases Google would need to go to $0 a share in order to lose the same amount of money from the common shares as if the option expires dead (less than $400 at expiration).

Disclosure: Long GOOG

Comments

[LA Tech:]

Google stock price will never close over $500 again in our lifetime.

The best performance for GOOG shareholders is in the rear view mirror!

May 13 10:53 AM

[joseph78:]

A bit risky, but Interesting. What do you think about the following strategy:

Buy Jan2010 380 Call and Sell Jan2010 430 Call. You will need roughly $2300 per contract and can make a maximum of $2700 or 120%. For this strategy to be profitable the price of GOOG has to be above $430 or just 15% over the current price and you break even @ $403.

I am also thinking about going even lower: Buy 340 Call, sell 390 Call, for this you need to invest $3000 and you can potentially make maximum of $2000. The price of GOOG however only has to stay the same and you can collect profits.

May 13 01:58 PM

[Marco Hickey:]

The first strategy seems like a good one to look at! Writing far in the money calls has never worked for me too well, but would pay off if GOOG stayed above current levels. I am bullish so they both seem good to me, but I take the risk of doubling-tripling my money most of the time. I bought Leap 11 100 strike Calls on GS in November for near $800 a contract. I just completed the spread and sold the $250 strike a few weeks ago for $500 a contract. The most I can lose is $300 per contract with GS $30 in the money and 600+ days until expiration. I think waiting on GOOG a while will serve me well.



On May 13 01:58 PM joseph78 wrote:

> A bit risky, but Interesting. What do you think about the following
> strategy:
>
> Buy Jan2010 380 Call and Sell Jan2010 430 Call. You will need roughly
> $2300 per contract and can make a maximum of $2700 or 120%. For this
> strategy to be profitable the price of GOOG has to be above $430
> or just 15% over the current price and you break even @ $403.<br/>
>
> I am also thinking about going even lower: Buy 340 Call, sell 390
> Call, for this you need to invest $3000 and you can potentially make
> maximum of $2000. The price of GOOG however only has to stay the
> same and you can collect profits.

May 13 02:42 PM

[Mikemx:]

I prefer GOOG bull put spreads. Instead of costing me money for the spread, I'm paid for it.

GOOG is at $389.50 at market close today. Convinced that GOOG is going up between now and Jan 2010? Do you believe (and think the data proves) that GOOG will be above $400 in January 2010?

OK then, let's start with SELLING the Jan 2010 $400 put for about $50 as of today. If GOOG closes above $400 On Jan 2010, you make $50 per share. But just selling that option would require a large amount of margin (around $21,000 per option).

But with a bull put spread, you can sell this option, and at the same time BUY a lower strike option, which limits your exposure (and margin), reduces your potential profit, but still let's you participate.

The Jan 2010 $360 put is priced near $33. If you buy this at the same time you are selling the Jan 2010 $400, here's what you get.

Sell $400 put option at $50, buy $360 put option at $33, for a net CREDIT to your account of $17 per share. If GOOG is above $400 on Jan 2010, you make and keep the $17 a share = $1700 per option spread.

What can you lose? If GOOG is below $360 a share, you lose the spread between 360 and 40 = $40 per share, but since you were paid $17 per share for the option spread, you net loss would be $17 - $40 = $23 per share = $2300 per option spread.

So, if you're convinced that GOOG is moving up, and are just sure it will be above $400, you can participate with a credit to your account today of $1700. You'll need approximately $2300 reserved in margin to make this put spread.

I like bull call spreads and bull put spreads, (and bear equivalents), depending on the stock and direction.

mike

May 13 08:45 PM

[Marco Hickey:]

thanks for your input mike


On May 13 08:45 PM Mikemx wrote:

> I prefer GOOG bull put spreads. Instead of costing me money for
> the spread, I'm paid for it.
>
> GOOG is at $389.50 at market close today. Convinced that GOOG is
> going up between now and Jan 2010? Do you believe (and think the
> data proves) that GOOG will be above $400 in January 2010?
>
> OK then, let's start with SELLING the Jan 2010 $400 put for about
> $50 as of today. If GOOG closes above $400 On Jan 2010, you make
> $50 per share. But just selling that option would require a large
> amount of margin (around $21,000 per option).
>
> But with a bull put spread, you can sell this option, and at the
> same time BUY a lower strike option, which limits your exposure (and
> margin), reduces your potential profit, but still let's you participate.
>
>
> The Jan 2010 $360 put is priced near $33. If you buy this at the
> same time you are selling the Jan 2010 $400, here's what you get.
>
>
> Sell $400 put option at $50, buy $360 put option at $33, for a net
> CREDIT to your account of $17 per share. If GOOG is above $400 on
> Jan 2010, you make and keep the $17 a share = $1700 per option spread.
>
>
> What can you lose? If GOOG is below $360 a share, you lose the spread
> between 360 and 40 = $40 per share, but since you were paid $17 per
> share for the option spread, you net loss would be $17 - $40 = $23
> per share = $2300 per option spread.
>
> So, if you're convinced that GOOG is moving up, and are just sure
> it will be above $400, you can participate with a credit to your
> account today of $1700. You'll need approximately $2300 reserved
> in margin to make this put spread.
>
> I like bull call spreads and bull put spreads, (and bear equivalents),
> depending on the stock and direction.
>
> mike

May 13 09:29 PM