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Friday, August 21, 2009

Google Upgraded: A New Option Idea Formed

On Google's fifth birthday, Goldman Sachs gave them a nice gift by adding them to their conviction buy list. I have been bullish on Google for a very long. Some of the reasons being:
  1. I don't ever see Yahoo or Microsoft taking too much [if any] of the advertising space away from them.
  2. They are growing cash flow and earnings at a very good rate.
  3. I find my daily routine revolving around google; from checking Gmail, and my blog stats on Google Analytics, to seeing how people found my blog with Google Webmaster tools, reading daily blogs on Google reader, to checking stocks on Google Finance, using Google Trends for research on some of my blog posts, reading breaking events on Google News (not to mention using the Google News timeline feature for blog posts as well), obviously for searching the web (I sometimes catch myself saying "google" it instead of search), and many more. I am sure many of you find yourself using Google as much, if not more than me every day. So why not be bullish on Google and why wouldn't I own it?
So on with the strategy...

With Goldman Sachs raising their six month price objective to $560 a share, I decided to use it as a price point for an option spread I decided to open Thursday morning. With Google nearing $450 a share Thursday, I looked for a strike which is deep in the money (delta as close to 1 as possible). This would allow me to use a lot of leverage when purchasing Google, and I chose deep in the money with high delta, so I could capture as much of the upside as possible. I chose the options expiration for March, 2010 (211 days until expiration). I purchased the 250 strike call options which traded for $202 per share (while the stock was approaching $450 per share), with a delta of 98.4 (for every $1 increase in Google stock the option increases by 98.4 cents per contract). Also note that I only paid $2 in option premiums, a trade off I'll take for getting almost all of the gains on the underlying shares for less than half the cost per share. I then made this a spread and sold the $560 March 2010 call option against my contracts for $9.60 per share, lowering my per contract cost to $192.40 a share, or $442.40 per share if exercised. Although March is one month short of Goldman's outlook; assuming it will expire above $560 this position would yield 61.1%. This position will lose money if the share price of Google is below $442.40 at March options expiration (March 20, 2010), and 100% will be lost if the unlikely happens and Google is trading below $250 a share at March options expiration.

This is a bullish strategy on Google, and should not be considered unless the outlook of Google's stock is very strong. To learn more about this strategy, and stock options in general click here. For a more bullish approach consider adjusting the strike prices and expiration dates. I am also long LEAP 2011 Google 300 call options, which I use as the base to write out of the money calls (Diagonal call spread) on every month to generate income for my portfolio. I trade these on a daily basis, purchasing the higher strike call option back on weakness of Google stock and writing it out on strength of Google stock.

This is just an example and not a recommendation to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares. To better understand options in general, including this strategy, these percentage calculations, and other option strategies, as well an option volume chart over the last 5 years click here.

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