What a week this is for the market. The combination of big tech earnings and the Fed meeting has the potential to lead to some big moves. Is it time for big tech to finally break its bearish cycle? Let’s take a look at Google (NASDAQ:GOOGL), whose earnings call is set for after the market close on February 2, and a trade idea to hedge our downside risk.
Like most tech, Google has been hit hard by the hawkish Fed stance and the equities overvaluation from 2021. Stuck in a clear downward channel since November 2021, we are finally seeing signs of a turnaround after twice finding support at ~$85.
However, while a good support zone has formed in the mid $80s, an even stronger resistance zone has formed at the low $100s. With multiple rejections plus the 200-day exponential moving average acting as a floating resistance coming into play, this area will be tough to break with a good earnings report alone and will take a dovish stance from Mr. Powell as well.
Valuation wise, Google looks quite attractive from a simple P/E perspective compared to the quarterly S&P 500 P/E ratio from the last 12 years. The overcooked market from 2021 appears to have overcorrected a bit giving a good entry point to this blue chip, wide-moat tech giant. Valuation is comparable to the average S&P 500 company, but the average company has not been doubling its revenue while also reducing share dilution.
Google is not without some headwinds though as the Department of Justice has filed a second antitrust suit against Google’s ad business and the market generally remains anti-tech during a higher interest rate environment. While an antitrust suit will possibly take years to play out, there is still a cheap and easy way to hedge against downside risk on a quarterly basis.
As outlined earlier, the $85 price area is a strong support zone. In the case of bad earnings news, more antitrust suits, general market headwinds, etc., it is always smart to have some downside protection and this seems like a likely area for the price to return to if the bear market continues. My favorite play for this scenario is a Calendar Put Spread. For those unfamiliar with this strategy, a calendar put spread is selling a put and then buying the same strike price put at a later expiration date.
Buy to Open 85P 3/17 expiration
Sell to Open 85P 3/10 expiration
I like this better than purchasing just a long put since this helps reduce the overall cost and theta (or time decay) and results in a smaller percentage decline if the stock rises since you have a sell on the board. In Google’s case, you can currently purchase downside protection in the $85 zone through March 10 for a $20 debit that could potentially increase eight times in value.
While the 8x increase is incredibly unlikely (it would require the stock price to be right at $85 a few minutes before closing on March 10), this strategy still gives you a good profit zone weeks before expiration. The above example shows max profit right at expiration, but what about a small decline a week from now?
A 4% decline in one week is a much more realistic possibility than being down exactly 13% on March 10 and while you will not see some crazy gains like you hear about on WallStreetBets, a 12% return on a downward move as shown below certainly helps as you can adjust the number of contracts to your position size/risk tolerance.
There are a few negatives to consider with this strategy, such as being highly sensitive to volatility. As implied volatility drops, the profitable range and max profit will narrow and the value can drop without the stock price moving. It will not be as sensitive to IV crush as a standalone long option since you have sell coverage, but the profit zone will shrink nonetheless. And of course, a move up in stock price will result in a loss which makes position sizing very important. Also, OptionStrat has a great platform but options calculators have their limitations since there are so many factors that can affect premiums.
While I currently like Google’s valuation and revenue growth, there are always macro factors and market sentiment that can negatively impact stock price. Until the $100-$104 price zone is broken, I will be cheaply hedging my position using the above strategy or something similar if the price enters the strong resistance zone.