Tuesday, April 30, 2013

GOOG: First bull signal since January

Update 6/7/2013: GOOG gave an exit signal on May 29 and I closed the position on June 7. The stock price gained 5.6% from initial entry to the exit. I rolled the position once and added to it several times. The gain on my basis was 3.1%. The vertical credit option spreads I used to construct the position produced a 19.4% gain on risk.

Google Inc. (GOOG) broke above its 20-day price channel on Monday, producing its first bull signal since January. The break above the channel boundary, $818, is the 22nd such occurrence since January 2009, when the broad markets began recovering from the post-recession crash.

The breakout was confirmed in Tuesday's trading as the price remained above the channel.

Twelve of the 21 completed trades since 2009 produced a profit, averaging 7.1%, compared to an average loss of 4.9% for unsuccessful trades. The success rate was 57%.

GOOG has been in an uptrend for so long that it's hard to pick a post-2009 starting point for the current trend. One reasonable candidate is early October 2011, when the price declined almost to the level of the prior low, rather than setting a clear higher low as part of a stair-step pattern.

During that period, GOOG has completed seven upside breakouts, five of them profitable, for an average yield of 5.8%. The two unsuccessful trades lost 4% on average. The success rate was 71%.

Like many widely traded stocks, GOOG trends toward moderation. There are so many minds making trading decisions that they tend to balance each other out when compared to less liquid shares, which can be moved great distances on the chart as a result of only a few decisions.

GOOG's yield, when adjusted by the success rate, produces scores below my 5% preferred minimum, 4.9% in the period from January 2009 and 4% during the current uptrend. The win/loss yield spread are also narrow: 2.2% for the long term and 1.8% for the current uptrend.

The run up since October 2011 began at $480.60 and continued up to $844 on March 6. From that point the price declined down to $761.26 on April 18. An earnings announcement after the close that day led to the seven day near-term uptrend that produced the bull signal.

Two other big names were on my break-out list from Monday's trading. The NASDAQ 100 exhcange-traded fund, QQQ, was eliminated because the odds were against success over the past year, and Amazon (AMZN) failed confirmation on its bear breakout.

Google, headquartered in Mountain View, California, is a household name and, despite the best efforts of the lawyers, a potential common noun in the making. It earns its living mainly though non-intrusive ads displayed on search results. And of course, as everyone knows, Google dominates global search.

Given that market dominance, it is not surprising that analysts following GOOG collectively come down to a fairly high 48% enthusiasm rating.

Google reports return on equity of 17%, just shy of growth-stock territory as I define it, with an extremely low level of debt amounting to just 4% of equity.

Looking at the last 12 quarters: Google has been consistently profitable with a fairly consistent quarter to quarter rise that has faltered only three times in the period. It's earnings have surprised eight times to the upside, and four to the downside.

Institutions own 83% of shares and the price has been bid up to a moderately high level; it takes $5.08 in shares to control a dollar in sales. Some price/sales ratio comparisons: Facebook (FB), $12.81; Microsoft (MSFT), $3.58; and Apple (AAPL), $2.39.

GOOG on average trades 2.8 million shares a day and supports a huge grid of option strike prices with open interest running to three and four figures and narrow front-month at-the-money bid/ask spread on calls of only 1.4%. As an options trader, I have a deep love for stocks like GOOG, that provide so much leverage and so many leveraging opportunities.

Implied volatility, however, is low, standing at 19%, near the floor of the six-month range. It has been declining since mid-April.

Options are pricing in confidence that 68.2% of trades will fall between $778.79 and $867.81 over the next month, for a potential gain or loss of 5.4%, and between $801.92 and $844.68 over the next week.

Options activity is a bit slower than it has been, with calls at 91% of their 5-day average volume and puts at 78% of average.

The fair-price zone runs from $817.91 to $821.89, encompassing 68.2% of transactions surrounding the most-traded price, $820.80. GOOG moved above the zone in the second hour of trading and remains there with a bit more than three hours to go before the closing bell.

Google next publishes earnings on July 15.

Decision for my account: I'm bending some rules on this one, but I've taken the trade, structuring it as a vertical credit spread expiring in May, short the $820 put and long the $805 put. This provides a fairly small cushion of 1.1%  before I hit the breakeven point. The maximum potential yield at expiration is 24.1%.

Broken rules: I've already mentioned going against my preferences on the scoring. My way of sizing trades falls apart complete when faced with a share price as high as GOOG's, so that best practice has been thrown to the winds. And, as noted in my most recent "Week Ahead", I shouldn't be trading vertical spreads at all at this point in the calendar.

I truly don't like breaking rules. Yet in the case of Google, liquidity and the story have trumped good practice. I can only hope that it hasn't also trumped good sense.

And after all, the rules were made for the trader and not the trader for the rules.


My trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

At several points in my analysis I use the number 68.2%. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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