Trading Google Before Earnings

Dec.30.11 | About: Alphabet Inc. (GOOG)

Google GOOG usually reports earnings on a third Thursday of the first month of the earnings cycle. This time it falls on January 19, 2012, three weeks from now. Below is the history of the stock's post-earnings moves in the last eight cycles:

(Click charts to expand)

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The stock can move both ways, but one thing is certain: the IV (Implied Volatility) of the options is going to spike as we get closer to the earnings date. The following chart shows the history of the IV for the last six months. I circled the area of the previous two earnings dates.

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As we can see, the IV started rising about three weeks before the earnings date. Currently the IV is still significantly lower than the pre-earnings levels.

There are many ways to play Google earnings. Some traders like to buy calls or puts and bet on the direction of the post-earnings move. My favourite way is buying a strangle a few days before earnings and selling it just before earnings are announced (or as soon as the trade produces a sufficient profit). The idea is to take advantage of the rising IV of the options before the earnings. I described the general concept here. In general, I look for companies having a history of big post-earnings price moves. Those big moves will cause the IV to spike before earnings.

With Google, I’m going to play it in a slightly different way. I’m going to buy an Out-of-The-Money (OTM) strangle and sell a further OTM strangle, creating a Reverse Iron Condor. I used this strategy to play AutoZone (AZO) earnings, and the trade produced a return of 20% in five days with very low risk. FedEx FDX trade was also successful, producing a 27% gain in six days.

I’m using this approach in two cases:

  1. When trading high-priced stocks, to reduce the cost of the trade.
  2. When the time to expiration is less than two weeks, to reduce the negative theta.

It can be used for stocks like Apple AAPL, Amazon AMZN, Intuitive Surgical ISRG, Wynn Resorts WYNN, Baidu BIDU and others.

Google is currently trading at $642. The trade I’m looking at is:

  • Sell GOOG January 2012 600 puts
  • Buy GOOG January 2012 610 puts
  • Buy GOOG January 2012 680 calls
  • Sell GOOG January 2012 690 calls

As of this writing, the trade can be done for about $4.75. I’m planning to place this trade next week. This is a debit trade, no margin requirements. My profit target is 25%-30%. The downside should be no more than 10%-15%.

The negative theta of the trade is currently about 2.4%. That means that, all other factors equal, the trade will be losing 2.4% per day. However, I expect the rising IV to offset the negative theta at least partially.

If the stock moves, it should help to increase the gains. My plan is to take the profits and roll to new strikes if the stock makes a decent move. And don’t forget to sell before earnings.

The main idea behind this trade is “renting the strangle” (or the reverse Iron Condor in this case) before the earnings. An increase in IV should help to neutralize the negative theta and keep the floor under the strangle price. As we know, earnings are 50/50. This is a trade for those who don’t want to bet on the direction of the stock and don’t want to hold through earnings.

Disclosure: No positions in any stocks mentioned. I'm planning to place the GOOG reverse Iron Condor next week