Thursday, July 16, 2009

Google Earnings

Tech giant GOOG is reporting earnings tonight after the bell, so let's take a look at what the options are pricing in and spotlight a few potential plays.

Remember, when assessing implied volatility we're trying to get a sense of whether or not options seem over, under, or fairly priced. For example, if current implied volatility on GOOG 30 day options is sitting around 40% and I expect GOOG stock price will only realize 10% volatility over the next 30 days, I would be of the opinion that GOOG options are overpriced. As such, I'd rather be an option seller(via maybe a short strangle or condor) than buyer. On the other hand if current IV is sitting at 10% and I expect GOOG stock price to realize 40% volatility over the next 30 days, I'd be of the opinion that options are too cheap. Thus, I'd rather be a buyer of the options (via a long straddle or strangle).

Currently 30 day HV on GOOG sits at 25% and 10 day HV sits at 32%.
A look at the implied volatility chart below shows that current IV is at 33%; a 7 pt. premium to 30 day HV, but seemingly right in line with 10 day HV.
Because July options expire this weekend, we can take a look at the July straddle to see how much of a move is expected in GOOG tomorrow.

Currently GOOG is trading around $440 and the ATM straddle (long 440 call + long 440 put) is trading at $21.70. For buyers of this straddle to have a profit they need GOOG to be above $461.70 or below $418.30. This requires a $21.70 or 5% upward or downward move. See the graph below:
So, if you think the options board is underpricing July GOOG options and that GOOG will gap up or down more than 5%, you may just want to be a buyer of this straddle. Keep in mind, although the volatility chart I showed previously has GOOG IV at 33%, per IVolatility their IV Index is


Because the 1 day remaining in July expiration will be drastically affected by GOOG earnings, the July options are trading at a much higher IV (85%), than is implied by the IV Index (33%).

So what if I think July IV is too high? Well, then I'd want to do a short volatility strategy, such as a short strangle or condor. Because GOOG is such a high priced stock, short strangles will have a pretty high margin requirement as well as a lot of theoretical risk- so let's review an iron condor instead.

Iron Condor:
Sell July 470-480 Call Spread @ $.60
Buy July 400-390 Put Spread @ $.65
Net Credit = $1.25
Max Risk = $8.75
To profit we need GOOG to remain between 400 and 470, which means it can't gap up more than $30 (7%) or down more than $40 (9%). If you think a gap that large is not in the cards, then entering a condor may be prudent. If you wanted to widen the range of the condor you may consider using August options instead of July-

By the end of today, GOOG may be trading much higher or lower than $440- which may necessitate changing strike prices on the aforementioned trades.

6 comments:

Bill Luby said...

Nicely done once again, Tyler.

I am a big fan of your P&L graphs here too. Can I asked what you used to generate them?

Cheers,

-Bill

Tyler Craig said...

Thanks Bill-

I use 2 programs to display the charts as you see on the blog.

For my charting and risk graphs I use the EduTrader software (edutradersoftware.com). It has the ability to juxtapose the risk graph with the price chart.

I then use Snag-It (snagit.com) to take a snapshot of the chart. In Snag-It Editor I add the red and green background to highlight the profit and loss zones.

I admit it would be nice if Edutrader automatically shaded it, but it's pretty easy to add it on Snag-It.

Also- I've appreciated the Retweets on Twitter.

Mob said...

Tyler, still am a daily visitor...;)

AH GOOG dropped 3.3% (midnight) coming closer to max pain of 420. I have asked this question twice on other boards without having received any comments - is max pain (optionpain.com) a useful tool to determine OPEX targets and is it statistically significant (I can not find any long term analysis on this anywhere).
Appreciate your comments & thanks for all the work you put into the site

Tyler Craig said...

I'm not well versed with max pain- so I'll take a look at the site and give you my thoughts-

Tyler Craig said...

Mob,

Didn't really find much info elaborating on max pain theory. I'm somewhat familiar with trying to find stocks that have a high probability of pinning on a specific strike at expiration, but have never really used it much in my own trading. I'm not sure if there are any services that give you a list of good pinning candidates each expiration cycle, but it seems to me that it would be cumbersome process to find pin candidates yourself ever expiration cycle. I'd rather play other strategies that are easier to identify and exploit. I don't know anyone that consistently plays pinning strategies.

If you're up for reading, Jeff Augen has a book the throws out ideas for srategies that can be implemented at OPEX called Trading Options At Expiration.

Mob said...

Thanks Tyler, for going through all the trouble to "enlighten" me - will have a look at the book!
Have great weekend!