Trading Google Options on Goldman's Upgrade

On Google's (GOOG) fifth birthday, Goldman Sachs (GS) gave them a nice gift by adding them to their conviction buy list. I have been bullish on Google for a very long. Some of the reasons being:

1. I don't ever see Yahoo (YHOO) or Microsoft (MSFT) taking too much [if any] of the advertising space away from them.
2. They are growing cash flow and earnings at a very good rate.
3. I find my daily routine revolving around Google; from checking Gmail, and my blog stats on Google Analytics, to seeing how people found my blog with Google Webmaster tools, reading daily blogs on Google reader, to checking stocks on Google Finance, using Google Trends for research on some of my blog posts, reading breaking events on Google News (not to mention using the Google News timeline feature for blog posts as well), obviously for searching the web (I sometimes catch myself saying "google" it instead of search), and many more. I am sure many of you find yourself using Google as much, if not more than me every day. So why not be bullish on Google and why wouldn't I own it?

So on with the strategy...

With Goldman Sachs raising their six month price objective to $560 a share, I decided to use it as a price point for an option spread I decided to open Thursday morning. With Google nearing $450 a share Thursday, I looked for a strike which is deep in the money (delta as close to 1 as possible). This would allow me to use a lot of leverage when purchasing Google, and I chose deep in the money with high delta, so I could capture as much of the upside as possible. I chose the options expiration for March, 2010 (211 days until expiration). I purchased the 250 strike call options which traded for $202 per share (while the stock was approaching $450 per share), with a delta of 98.4 (for every $1 increase in Google stock the option increases by 98.4 cents per contract). Also note that I only paid $2 in option premiums, a trade off I'll take for getting almost all of the gains on the underlying shares for less than half the cost per share.

I then made this a spread and sold the $560 March 2010 call option against my contracts for $9.60 per share, lowering my per contract cost to $192.40 a share, or $442.40 per share if exercised. Although March is one month short of Goldman's outlook; assuming it will expire above $560 this position would yield 61.1%. This position will lose money if the share price of Google is below $442.40 at March options expiration (March 20, 2010), and 100% will be lost if the unlikely happens and Google is trading below $250 a share at March options expiration.

This is a bullish strategy on Google, and should not be considered unless the outlook of Google's stock is very strong. To learn more about this strategy, and stock options in general click here. For a more bullish approach consider adjusting the strike prices and expiration dates. I am also long LEAP 2011 Google 300 call options, which I use as the base to write out of the money calls (Diagonal call spread) on every month to generate income for my portfolio. I trade these on a daily basis, purchasing the higher strike call option back on weakness of Google stock and writing it out on strength of Google stock.

This is just an example and not a recommendation to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares. To better understand options in general, including this strategy, these percentage calculations, and other option strategies, as well an option volume chart over the last 5 years click here.

Disclosure: Long GOOG January 2011 Leap 300 Call options, GOOG March 2010 250 Call options, Short GOOG March 2010 560 Call options

Comments

[TradingHelp...:]

Great article. I too think GOOG still has potential. Wave and Chrome OS have a lot of potential. GOOG is still fresh and exciting.

Aug 21 12:10 PM

[LA Tech:]

Sounds like a giddy group of Google investors. Google will never get within 100 points of it's all time high...ever!

Aug 21 12:23 PM

[modelportfo...:]

@TradingHelp. Agree with Wave and Chrome OS potential upside but it is interesting that neither was a reason given by Goldman for their upgrade to the Conviction Buy List and increase of TP from $510 to $560. Instead, to GS, it was all about the macroeconomic rebound in Google search, esp in Europe where Google market share can be as high as 90% in some countries but where search rev from paid clicks is only about 1/3rd or less the level of US/UK which they hold out as a benchmark target level. So really, what they are saying is that their basic search business, provided they do the basic tackling, is enough to boost their revenue growth back into the teens (from 3% recently). GS believes market will reward Google with higher p/e also because many of their clients who derive a majority of their revenue from Google ads and traffic are trading at higher p/e's than Google, which they believe to be an anomoly. Also they believe Google's growth rates from display advertizing (DoubleClick/YouTube) will move the dial in next year.

Bottom line: anything on top of the above contributions from Wave, Chrome OS, Android and the myriad amount of advertizing revs derived from these and the apps used by the author, Marco Hickey, would be gravy.

Aug 21 12:32 PM

[modelportfo...:]

@LA Tech. When the market gets wind of Google earning $25 in 2010 and $30 in 2011 and begins to discount 2011 eps to a fair value of say $650 (your "never" price), that would put Google on a forward p/e of 21 times which is hardly a stretch for a company growing earnings at 20% pa. Read it and weep. Guess you are short?

Aug 21 12:37 PM

[Lindylou:]

When every idiot says "Buy" then it's time to sell. Google is so far overpriced and it's too much on the radar.
Remember what they said about "Super Q" -- Qualcomm? Exact words they're using now.

Aug 21 06:45 PM

[B12B:]

I too am so enamored by all things Google>>Chrome, gadgets on the desktop, gmail and search generally. Even have begun using search as a spelling tool: when not sure of the spelling of a word, I begin typing it and as I progress the full word forms in the dropdown and reveals itself. I am awaiting the day Chrome OS will become available and hope to see it and Android influence Apple's OS, Safari and all things Apple to forge [forge?] compatibility between these two superior technologies/products. I love my iTouch!!
b

Aug 22 09:19 AM

[TCK:]

Clarification;

This is a $19,240 trade ?

Aug 23 04:22 PM