A Couple of Ways to Play Google (GOOG) Earnings

While Google GOOG is not exactly known for a complete lack of volatility around earnings, its movements have not been all that violent (on a percentage basis). Thursday’s earnings report may be a pivotal one for Google, with the smartphone wars continuing to heat up.

The Blackberry, part of the Research in Motion RIMM family, still leads the sector with a 41% market share in the U.S. and of course the iPhone craze powers on, but Google’s Android operating system is still growing at an exponential rate. I like to think of it as the 1980s Microsoft MSFT/Apple AAPL saga, redux. Back then, MSFT, like Google, offered its “window” operating system to multiple computer makers. In doing so, the company got folks across the world and on different hardware platforms addicted to its products.

Apple, in typical Jobs’ style, only sold its operating system software (and all software, for that matter) for Apple-made PCs. This strategy hurt Apple in the early days. Obviously, things have improved for the company and now the iPhone is like the Rubik’s Cube of the 2000s. Apple has done a good job at getting the public addicted to a cool (albeit flawed) product. Now that Consumer Reports won’t bless the iPhone 4 because of antenna issues, I’m looking forward to seeing how Apple spins it.

Now, with all of that, back to Google and its universal operating system that is pretty darn cool. The Android system is smooth, fast, and used by many makers of phones that are offered by just about every carrier. Google’s new “App Inventor” will make the creation of potentially profitable applications a possibility for nearly everyone. There are some, however, who believe the glut of “useless” apps could be a negative. Regardless, if more people are using the products, in my opinion, that could translate to a positive for Google and Android (think an equivalent of Microsoft Office).

This quarter will also hopefully give us more insight into Google’s China situation. The company’s decision to square up against China and redirect users to a less restrictive site based in Hong Kong seemed to coincide with a sharp decline in the stock price. Chinese officials recently approved Google’s registration and ability to operate within the country for another year, but all is not over with the Google/China saga and the renewal does come with some potentially negative caveats.

So coming into this report on the 15th, consensus expectations are for $6.54 per share (quarterly), and the high and low estimates are $6.82 and $6.06, respectively. Google, on average, tends to move less than 5% in the session immediately following earnings. As I mentioned earlier, however, this report could create added volatility based on some of the points I discussed above (and how Google is handling them).

The options markets don’t seem to expect added volatility. As of Tuesday morning, the July 480 straddle, which expires Friday, is trading for $22.00 ($3.00 parity), or about 4.6% of strike. This means the options markets seems to think Google may stay within roughly a $44 range until Friday.

Even though the options markets are pricing in a relatively moderate move over earnings, out-of-the-money vertical spread strategies provide a bit of wiggle room in case the market is wrong and GOOG shares respond more dramatically to its report on Thursday. If you are bullish and want to give yourself (and Google stock) some wiggle room, you could consider selling the August 420/410 put spread for $1.00, which would reduce your risk to $9.00 and place your potential return at $1.00. If Google can stay above $420 by August expiration, you could potentially return 11% on your risk in that five-week period. The maximum loss of $9 would occur if the stock was trading below $410 at August expiration.

If you want to take the other side with a moderately bearish stance, you could also examine selling the August 540/550 Call Spread for $1.00, which would offer the same risk/reward characteristics. In this case, however, you would potentially net 11% return on your risk with GOOG trading below $540 at August expiration. The maximum loss of $9 would occur if the stock was trading above $550 at August expiration.

Both of these strategies are limited in risk and reward and the breakevens on both are outside of a one standard deviation move in GOOG by August expiration. This qualifier could potentially give investors a statistical edge.

*Option prices given as of Tuesday morning.

Photo Credit: Robert Scoble

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