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Two Ways to Play Google Earnings

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Not much time to think about it, but an iron condor may be a good option.

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So once again, Google (GOOG) will report earnings on the eve prior to options expiration. This allows all of us speculators to think, and make no mistake, anyone who plays earnings let alone options on earnings is speculating, which is a fancy word for gambling.

As I cogitate on what the right approach might be, there are two basic issues to address.

First, what do I think the expected response to the report might be? Within this, there are three outcomes: big move up, big move down, or a relatively small move or no change in price.

Second, I look at the implied volatility of the options to calculate approximately what is being priced in or expected by the option market.

Working backward, it looks like Google options are currently pricing in about a 5.5%, or $29, price move. In dollar terms, that might seem like a lot, but in percentage terms, and given some of the past earnings moves which have averaged around 7% over the past two years, it's relatively conservative for the options.

The Big Move

To simplify the approach to playing a big move, I'll do away with trying to guess bullish or bearish and just assume the move will around the 7% range one way or another. This means setting up essentially two separate positions. If one has a specific bias, they can choose either approach in isolation.

The strategy I'm considering is a skip strike butterfly, that's one that has a 1x3x2 construction. Let's focus on the bull or call side.

For example, one could buy 1 October $540 calls, sell 3 October $560 calls, and buy 2 October $570 calls. Based on midday prices, this position will cost around a $1.30 net debit. The cost is equal to the maximum loss, incurred if shares are below $540 or above $570, which is an 8.5% move to the upside. The maximum profit is $18.70 and is realized if Google is at $560, or 6.8%, at the Friday expiration.

A similar position can be set up on the put or bearish side. For example, using the $510/$490/$480 strikes would cost around a $2 net debit.

Taken together, the positions will cost a total of around $4, which is the maximum loss if shares are between $510 and $540 or below $470 or above $570 a share. The maximum profit is $16 if shares are at $490 or $560 at expiration.

Obviously, with a 1:4 risk/reward, this is a low cost high pay-off approach. But with that risk/reward profile it comes with relatively low odds. That is you need to really nail either the $490 or $560 price points. Any move less than 3% or greater than 8% will result in the max $4 loss.

Stuck in the Middle

If you believe shares of Google will remain somewhat range-bound then I would, and am, considering, an iron condor

In this case, one can sell the $550/$560 call spread for a $2 net debit. And simultaneously sell the $500/$490 put spread for a $2 net credit. That is a total of a $4 net credit.

The $4 is the maximum profit which is realized if shares are between $500 and $550 on Friday's expiration. The maximum loss is $6 and would be incurred if shares are below $490 or above $560 on expiration.

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No positions in stocks mentioned.

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