/shutterstock_1953091483.jpg)
Put option premiums for Alphabet (GOOG) stock are high ahead of its earnings release due out on April 25, after the market closes. This is attracting short sellers to out-of-the-money short put trades in GOOG stock in order to create profitable income plays.
Analysts expect to see earnings per share (EPS) of $1.07 for the quarter and revenue of $68.8 billion, according to Seeking Alpha. GOOG stock, trading at $105.91, has essentially been treading water since our last article on March 26, “Shorting Google Puts Is Popular As the Stock Remains Cheap.” The stock was at $106.06 then and has traded sideways, closing at $105.91 as of April 21.
I argued then that GOOG stock was cheap, trading at 21x forward earnings estimates for 2023 and 17.5x for 2024, well below its historical average of 25x. Part of the reason it is cheap is investors are worried about the challenge of artificial intelligence (AI) bots and competitors to its core search business. Investors will be looking to see if there are any potential chinks in the wall. This is despite the launch of Alphabet's own AI chatbox, Bard.
Moreover, analysts are also concerned about a dip in ad revenue, either from search or YouTube, or both. That affects cash flow. The fear is that Alphabet will report lower free cash flow and potentially lower buyback activity.
As a result, these fears are pushing up put premiums in the near term. That makes them attractive to investors who short near-term expiration out-of-the-money (OTM) puts for income.
Shorting OTM GOOG Puts
In my last article, I discussed shorting the $97.00 strike price put option that expires on April 28. This trade has worked well since the $97.00 strike price puts were trading at $1.89 per contract. But today, those same puts are now down to just 35 cents.
This is exactly what a short seller wants to see. For example, at the time the short put trade yielded almost 2.0% on a yield-to-strike basis (i.e., $1.89/$97.00). But even if we consider this as a dividend, i.e., divide the put premium by the stock price then. That means at the time the put provided a yield of 1.78% (i.e., $1.89/$106.06).
Now, with the puts having depreciated so much, over 82% from $1.89 to $0.35, that means the investor who shorted those puts has made most of the 1.78% yield foreseen at the time.
The investor can either decide to roll this trade over, by buying back the shorted put expiring on April 28 and then shorting a new put, or just enter a new trade. For example, the May 19 put option chain shows that the $95 strike price puts trade for 82 cents.
This means that the investor who secures $9,500 in a brokerage account and enters in an order to “Sell to Open” 1 put option contract at $95.00, which is 10% below today's price of $105.91, will immediately receive $82 in the account. That works out to a yield-to-strike of 0.863%, or 10.4% if this could be repeated every month for a year.
Moreover, investors willing to take on more risk can short the $100 put options. After all, this strike price is extremely popular with over 11,000 contracts open at this price. As can be seen in the table above, the $100 puts are trading for $1.77. That means they provide a 1.77% yield-to-strike return, which is equivalent to a 21.2% annualized return if it can be repeated for 12 months.
The risk here is that this strike price is only 5.58% below the spot price of $105.91. GOOG stock could easily dip this much if earnings out on Tuesday are not as good as analysts expect. However, this may not be as bad as it might seem, since the breakeven price, after deducting the income received, is still just $98.23 per share (i.e., $100-$1.77). In other words, GOOG stock would have to drop by 7.25% from today's price.
The bottom line is that investors can expect to earn good income shorting out-of-the-money puts in GOOG stock. This is taking advantage of the high put premiums given the fears about how Alphabet's earnings will turn out.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
