Trading at just 21X earnings and projected earnings growth of 14% in 2011, Google (NASDAQ:GOOG) has become an oversold value stock. With Google pinning to 490 on options expiration Friday, it confirmed a nice breakout and could be a potential trend reversal for the search giant. As an options trader these pattern breakouts are key when choosing my strategies. Following the marked up chart of Google below, I will highlight some key points which led me to put on a bullish option strategy.
Why I am bullish: From the chart above you can see Google broke a major down triangle on September 13 (blue lines). This breakout projects Google back up between 520 and 550 per share. However, that is just the beginning... You can also see from this chart above a very choppy inverse head and shoulders pattern with the neckline coming in around 510 per share (yellow dotted line). This 510 level is a key resistance area and if it can break above that (as the triangle breakout suggests) the stock could run back up and test its recent high near 590 per share.
How I am playing it: I am playing quite conservative by purchasing October Call Spreads. I plan on purchasing October 510 calls (the neckline breakout point) and selling the October 540 calls against them. I can get into each spread for a net debit of around $550 which doesn't seem too expensive considering an earnings report falls in that time frame. The reason I'm not purchasing just October calls is because I don't want to purchase too much volatility with the Google earnings announcement falling before expiration (selling an upper call against the lower call will help offset this). The reason I'm not purchasing November calls or call spreads is because I don't want to purchase too much time in case Google sells off. If significant profits can be taken, I may choose to close my position before earnings.
Number Crunch: The most that can be lost from each 510/540 call spread is $550 (plus commissions) and will result if Google closes at or below 510 per share on October expiration. The break even point from this spread is shares of Google at 515.50 (less commissions) per share on October expiration, anything above that price until 540 per share will result in unrealized profit. If Google closes at or above 540 per share on October options expiration it will return the maximum of $3,000 per spread or 545%.
As stated, I believe Google is oversold and will use any dips after earnings or in the near future to accumulate shares for my investment account. I still think in order to get some real momentum behind this stock, Google needs to purchase shares back of the company, do a stock split, or declare a dividend... I would be a fan of all three.
The ideas outlined above are bullish strategies and should not be considered if you think the stock will sell off in the near future. However if you feel the stock could move higher in the near future, this strategy could yield a nice gain. These are just examples and are not recommendations 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 five years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.
Disclosure: Long GOOG October 510 Calls, Short GOOG October 540 Calls