Update 8/4/2015: GOOGL has pulled back only slightly from its gap peak. I've exited the calls, transforming the position into a bull call spread. I'll calculate profit and loss upon expiration on Aug. 22.
Update 7/18/2015; GOOGL closed up $97.84 after earnings were published, an increase of 16.3%.
The $699.62 post-earnings close is well above the implied volatility two-standard-deviation peak of $631.78. The magnitude of the rise is quadruple the greatest post-earnings rise of the past year.
It may not exactly be a black swan. Earnings surprises are to be expected. And indeed, the Wall Street chattering class attributed the bump to solid earnings, Bloomberg reported in a round-up by Julie Verhage.
But given the size of rise, this swan certainly is a darker shade of gray. Implied volatility on the options certainly didn't expect it.
GOOGL at Friday's peak stood 14.3% above the stock's previous all-time highest of $615.04, a level attained in February 2014.
Click on chart to enlarge.
|GOOGL at close on July 17, 2015, 11 years weekly bars (left), 30 days hourly bars right)|
If I had exited at Friday's close, shares would have risen by 18.6% above my entry price over the one-day lifespan of the position, or a +6,780% annual rate. The options would have produced a 57.9% loss on debit, for a -21,053% annual rate.
Bad, but certainly not the worst loss I've seen. In trading, losses happen, and when they do, I manage the exit, do a lessons-learned, and move on to the next chance.
Some considerations that I'll bring to the management:
- Google shares tend not to retrace large post-earnings movements. However, none in the 11-year history of the stock have equaled this one in single-day magnitude. Also, previous large movements have happened when Google was in an uptrend. It has been in a sideways trend since February 2014.
- The magnitude of the movement came as a surprise to the markets. Google had been experiencing some problems. It seems likely that, given the competence shown by the management, the company would be able to come back, there was never any guarantee that it would do so this quarter. The actual earnings were 3.9% above the consensus forecast. Surprise often produce outsized responses that are mitigated in the harsh light of second thoughts.
- My options positions don't expire until Aug. 21.
- Options are pricing in only a 9.6% chance that the calls with the $615 strike will expire out of the money for maximum profit. That's fairly dismal, but significantly greater than zero. I've bet on worse odds before, and won.
I have three choices: Exit immediately. Exit later. Partially exit at some point.
I'm rejecting exit immediately. Because of the gray swan nature of the movement, I think there's a reasonable expectation of at least some pullback that will mitigate my loss if I wait a bit before pulling out.
The third choice, a partial exit, is by far the most interesting, and perhaps the most promising. Time risk is always a concern when I'm in a winning position. The longer I hold it, the more likely it is that something will happen to cause the price to move against me and wipe out my potential profits.
But with a losing position, time risk suddenly becomes my friend, changing to time opportunity. If I can put off exiting, then the longer I wait, the greater the chance that the price will move in my favor, lessening the loss and even -- knock on wood -- producing a profit.
It works like this: My GOOGL position is an iron condor, a portmanteau structure built from a bear call spread and a bull put spread. All of the losses on the position are due to the bear call spread, of course. with the short leg having a $615 strike price.
The bull put spread is deep into profitable territory. If I cut free from the losing half of the iron condor, then I reduce my risk of further losses. I also have the possibility of rolling forward to a later expiration, gaining a small credit and increasing the time span.
The partial exit makes sense if the price remains steady or continues to rise and if there is still profit to be made on the bull put spread. The roll makes sense if implied volatility is still relatively high.
Neither condition holds at this point. The bull put spread produced a $3.10 credit, and it would cost me only 5 cents to exit at this point. The spread is pretty much played out.
Implied volatility fell sharply after the earnings announcement and now stands in the 25th percentile of the most recent rise, and 47% of the one-year peak. Neither level meets my guidelines, which are the 70th percentile or more of the most recent rise, or at 50% or greater of the one-year peak.
On the other side, the bear call spread half of the iron condor is 40 cents away from its maximum loss of $11.90. It might be worth exiting that soon if the price continues to rise, to forestall that relatively small additional loss.
At this point, my strategy is to wait and see, putting off the decision for a week or two (while, of course, watching the chart like a hawk).
The diversified technology company Google Inc. (GOOGL), headquartered in Mountain View, California, publishes earnings after the closing bell on Thursday.
[GOOGL in Wikipedia]
Click on chart to enlarge.
|GOOGL at 11:15 a.m. New York time, 30 days hourly bars|
I shall use the AUG monthly series of options, which trades for the last time 36 days hence, on Aug. 21.
|Week||SD1 68.2%||SD2 95%||Chart||Earns|
short the $565 puts and long the $550 puts,
sold for a credit and expiring Aug. 22.
Probability of expiring out-of-the-money
The risk/reward ratio is 1.4:1.
The zone of profit in the proposed trade covers a $25 move either way. The biggest immediate move after each of the past four earnings announcements was $24.29, and the average was $19.66.
Decision for My Account
I've opened a position in GOOGL as described above.
-- Tim Bovee, Portland, Oregon, July 16, 2015
My volatility trading rules can be read here.
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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.
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