Thursday, April 12, 2012

Google Inc. (GOOG) - Earnings Preview and Pattern; A Substantial & Unambiguous Risk Premium Statement Reflected by the Options

GOOG is trading 643.58, up 1.2% with IV30™ down 5.9% as of ~10:05am EST. The LIVEVOL® Pro Summary is below.


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Google Inc. (Google) is a global technology company focused on improving the ways people connect with information. The Company generates revenue primarily by delivering online advertising. As of December 31, 2011, the Company’s business was focused on areas, such as search, advertising, operating systems and platforms, and enterprise.


Let’s keep it simple -- this is an earnings note on GOOG on the last trading before the calendar Q2 report. The current vol level is not trivial in that there is a substantial and unambiguous risk premium statement reflected by the options relative to the past and I’m going to show how to find it. And, with weekly options expiring tomorrow, we have a precise measure of the option market’s pricing of the one day earnings move.

First, let’s start with the Charts Tab (six months), below. The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

On the stock side we can see the last two earnings moves (down $53.58 or 8.4% on 1-20-12 and up $32.69 or up 5.8% on 10-14-2011). Now look to the vol portion, and specifically the implied. For the 10-13-2011 cycle, IV30™ hit 43.09% and on 1-19-2012, the IV30™ hit 48.23%. The IV30™ today is just 31.37% and is down today.

But that’s just the beginning. Let’s take an eight quarter look back window using Livevol® Excel. The details and stats are included below.

That’s a lot of info, so let’s break it down into means and medians.

In terms of one day straddles, buying the front month straddle the day of earnings and selling on close the next day was a winning strategy six out of the last eight quarters. The average return was 62.8% and the median was 71.7%. Looking more closely to the most recent quarters, we can see the one day trade was a winner once and loser once, while the win was substantially larger than the loss.

Day before IV30™ mean (eight quarters): 34.60%
Day before IV30™ median (eight quarters): 31.65%
Day before IV30™ mean and median (two quarters): 45.66%

So, in English, we can see that other than the last two quarters, the current IV30™ is almost identical to the median over the last eight quarters.

Taking a more holistic approach, we can see that the last two earnings cycles are sort of on an island – priced to higher vol than the six quarters before. The vol today looks more like the six quarters prior than the most recent two quarters.

One-day Stock Moves
Absolute Mean (eight quarters): 7.95%
Absolute Median (eight quarters): 7.93%

It’s comforting to see that incredibly close tracking of mean to median simply in that it shows us we may have a reasonable measure of middle. In English, over the last eight quarters, GOOG stock has moved just under 8% in the day immediately following earnings. The standard deviation of the absolute moves is 3.11%. That's evidence that the measure of middle is in fact potentially meaningful -- but keep this mind when looking to the analysis to follow.

Let’s turn to the Skew Tab and then the Options Tab to complete the analysis.

I’ve purposely included the weekly options expiring tomorrow. We can see the beautiful and monotonic elevation in vol from the back to the front. This is normal and expected behavior. But, with the weeklies expiring tomorrow, we have a precise measure of option market pricing for the one-day move. Knowing that the stock has averaged ~8% a day over the last eight quarters, let’s look to the reflected risk now. The Options tab is included below.

To be as precise as possible, we’ll use the $643.58 spot as of this writing, which is 28.4% the 640 strike and 71.6% the 645 strike (0.284*$645 + 0.284*$640 = $643.58). The ATM straddle then is priced to:

ATM straddle = 0.284*($21.10 + $17.70) + 0.716*($18.6 + $20.25) = $38.84

And finally, turning that into a percentage of stock price:
$38.84/$643.58 = 6.03%

So, for those that are number averse or simply don’t have the time to follow that stuff, the option market is pricing the one day earnings move AND the rest of Thursday’s move as 6.03% when over the last eight quarters the single day move has averaged (and in median) 7.95%. Keep in mind the stock has already moved 1.2%, so Thursday's piece of the ATM straddle isn’t trivial.

I wrote about this one for TheStreet (OptionsProfits), so no specific trade analysis here.
Bringing it all together, GOOG vol is pricing a one day move off of earnings less than the eight quarter average (and median). Now the question... Do you expect GOOG to move more, less or about equal to it’s recent average? Perhaps a bit more holistic, is the current macro environment more or less “risky” than the past? Question number 2 is not trivial... for that matter, neither is number 1.

This is trade analysis, not a recommendation.

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