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Options for Google Earnings


A low-cost way to catch a big move.


For more options ideas and analysis from Steve Smith take a 14 day FREE trial, to OptionSmith.

Google (GOOG) is set to report earnings after the bell today, and many investors think the stock is set to bust out of the $360 to $380 range it's been trading in for the past 3 weeks.

As seems to happen more often than not, Google's earnings release is coming 1 day prior to option expirations - which sets up some interesting opportunities.

If you think Google is going to rise or fall more than 10% on the earnings report, you might be tempted to put your chips on the table and buy some puts or calls. Understand: This is a risky and expensive proposition. As of Wednesday's close, with the stock trading around $380, the April $380 calls were around $15 per contract, giving it a breakeven of $395 - or a 4% move. If you don't want to pick a direction and want to buy the straddle instead, it would cost $30 - meaning you'd need an 8% price move just to break even.

Some people might want to benefit from an immediate 5%-10% price move, but don't want to pay a lot. Is there an option strategy that's right for them? There just might be.

Getty Ready to Fly

It's a variation on a butterfly spread. Typically, a long butterfly consists of a 1 x 2 x 1 construction, using consecutive or equidistant strikes prices in which one buys the wings and sells the body, or middle strike. Such a position usually offers a very attractive risk/reward ratio: typically close to 1 to 4 (risk 1 dollar to make 4). The maximum profit is realized if the underlying's price is at the middle strike at expiration.

The drawback of butterflies is that, because they're a multi-leg spread position in which the delta and vega remain pretty much the same regardless of the underlying price, a profit cannot be realized until it's just a day or 2 away from expiration. But with Google reporting just 1 day before April expiration, implied volatility (IV) will collapse following the release - which means the position will benefit from the decline in premiums.

Skip to My GOOG

I'd actually look at slight variation on the standard 1, 1 x 2 x 1 construction and consider a skip-strike butterfly. This uses a 1 x 3 x 2 construction with 2 strikes, or the proportional amount, separating the 1 long contract from the 3 sold short. Based on Wednesday's closing prices, here's an example of how this might be constructed in Google.

  • Buy 1 April 400 call for $7 a contract

  • Sell 3 April $420 calls for $3 a contract

  • Buy 2 April $430 calls for $1.90 a contract

This can be done for a net debit of around $2, which is the maximum risk. The maximum profit of $18 is realized if Google is at $420 - an approximately 10% move on Friday's expiration.

I like the risk/reward of nearly 8 to 1, but what's really attractive is that with just 1 day to go to expiration, this basically is like buying the 400/420 call spread for just 3 dollars. If you actually bought that April $400/$420 call spread, you might expect to pay $5.50 at today's prices. So how can I offer you this great position at a nearly 50% discount? Well, if Google really shoots the moon and rises above $430, the position will incur the $2 maximum loss. A straight vertical spread would achieve its maximum profit no matter how high shares of Google flew.

A similar position can be done on the put side: buying 1 April $360 put, selling 3, $340 puts and buying 2, $330 puts for net debit of about $2.50. Maximum profit of $17.50 is realized if Google shares are $340 on Friday's expiration.

I'm going to try to put one of these on today for the OptionSmith portfolio. I'll let you know how it works out.

For more options ideas and analysis from Steve Smith take a 14 day FREE trial, to OptionSmith.

No positions in stocks mentioned.

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