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Alphabet (GOOG, GOOGL) stock has tumbled over 10% in the last month, especially since it released earnings on Feb. 2. Nevertheless, shorting out-of-the-money put options is still popular with value investors.
I described this in my article on Feb 5, “Alphabet's Earnings Are Mediocre, But Short Put Plays Are Still Hot.” The company had lackluster revenue growth in 2022 and lower free cash flow (FCF) in 2022 compared to 2021.
Moreover, analysts have turned slightly negative on the stock, given the rise of OpenAI ChatBot search threat to its underlying earnings. For example, one analyst in Seeking Alpha argues that Alphabet's artificial intelligence BARD chatbot will likely increase its cost of search by 10x if it takes off and cannibalizes its existing search platform.
As a result, GOOG stock is off 10.87% in the past month and GOOGL stock is down 9.78%. GOOG stock is also down 22% in the last six months.
That has taken GOOG stock down from $108.82 on Feb. 2 to $89.35 as of Feb. 24. Now the stock's implied volatility has also risen. That makes its put options more popular with investors as an income play.
Out-of-the-Money Short Put Plays Are Still Popular
We last discussed shorting out-of-the-money (OTM) puts at the $100 strike price for GOOG stock for both the March 3 and March 10 expiration periods. Since then the stock has tumbled dramatically to $89.35. Obviously now the investor would have had the short put contract exercised.
That means that the investor had to purchase GOOG stock at $100 and now has an unrealized loss. However, the March 3 put contract brought in $1.29 and the March 10 contract paid $1.45, so the breakeven levels were lower at $98.71 and $98.55 respectively with the stock at $89.35 today.
As a result, the investor now has a $9.36 loss on the March 3 contract and/or a $9.20 loss on the March 10 contract investments. This works out to a 9.48% loss on the March 3 contract (i.e., $9.20/$98.71)and a 9.33% loss for the March 10 contract investment.
Nevertheless, this is a similar loss that any other investor would have in the past month. Moreover, the investor can be comforted that the stock is cheaper, trading for just 17.5x forecast earnings, according to estimates of analysts surveyed by Barchart and Seeking Alpha. This is well below the average 25.4x multiple over the past 5 years, according to Morningstar.
Now the investor can either short out-of-the-money covered calls, and/or further OTM short puts. For example, in the latter case, the March 10 $85 strike price puts are trading for 65 cents per put contract.
This means that the short put investor can secure $8500 in cash and/or margin with their brokerage firm and enter an order to “Sell to Open” one put contract at the $85 strike price. This may not be as difficult in terms of new cash requirements now since the investor already has a margin balance from the long shares owned in GOOG stock. The investor then will immediately receive $65.00 in the account.
That works out to a yield of 0.765% in just 2 weeks before expiration. So on a monthly basis that is a 1.53% monthly return or 18.35% if repeated over a year.
That is a very good return for the next two weeks, especially since the stock would have to fall another $5.00 to $84.35, or 5.59% by March 10. In other words, despite the unrealized loss of $9.20 from the earlier short put contract investment, the investor can lower that loss by shorting more puts with little to no further investment in terms of margin or cash requirements.
As a result, the investor can repeat this trade and wait for GOOG stock to turn around. As I have shown, this is not unlikely given how cheap the stock is on a historical basis.
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- 3 Reasons Why Bullish Unusual Options Volume for Cars.com (CARS) Makes Sense
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.
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