Dan Sheridan shows how to play Google. Nicole Wachs explains the details.

Today we introduce a new play - the Double Calendar! We will also cover when to enter the trade and when to exit. It sounds complicated, but when you break it down, it's pretty straight forward. The first part of the "double" is a Long Calendar Spread with Calls (Play #27) using call strikes that are out-of-the-money.  The second part of the trade is - you guessed it - a Long Calendar Spread with Puts (Play #28). The put strikes are also out-of-the-money.  Although the Double Calendar is not included, you can review the basic Calendar Spreads in the online version of The Options Playbook located in TradeKing's Education Center.

THE PLAY - The Double Calendar Spread

TRADE FORMATION

Here is a potential Double Calendar play based on prices from September 4, 2008:

Front-month Strike A Put: Sell to open 1 GOOG October 430 Put at $15.50

Front-month Strike B Call: Sell to open 1 GOOG October 490 Call at $15.10

Back-month Strike A Put: Buy to open 1 GOOG December 430 Put for $25.40

Back-month Strike B Call: Buy to open 1 GOOG December 490 Call for $26.60

 

Double Calendar spread entry: $21.40 net debit

Stock at entry: GOOG near $458

Day to enter: between September 18^th and 25^th (two to three weeks from now)

GOOG earnings date: October 16^th (unconfirmed)

Maximum gain: $19.60*

Maximum loss: $21.40 net debit

Break-even points at expiration: $407.08* and $530.79*

Profit target exit: when spread value is between $23.50* and $24.60*

Stop loss exit: when stock hits either one of the break-even points*

Time stop exit: October 9 (one week before GOOG's earnings announcement)

*All data assumes current prices, time until expiration and implied volatility levels. These numbers

are approximate and do not constitute a forecast. Actual figures will vary.

ALL-STAR COMMENTARY

The goal here is to get familiar with one type of Earnings Play. We have an underlying that has earnings coming up in the next six weeks - Google. There are usually two ways to skin this cat. One way is that you expect the stock to move wildly on the announcement and you decide to create a trade around that idea. Looking back historically at Google's trading patterns, this stock tends to move about 6-7% on earnings announcements. Another way is to make a play during the time period leading up to the news release. This period is typically quiet and the stock is mostly range-bound.

Big gaps are usually on earnings and not before. GOOG doesn't usually move that much two to three weeks before earnings. With this in mind, we are going to go with a stagnant, range-bound strategy - the Double Calendar - and exit before earnings are announced.

The Double Calendar tries to capitalize on several factors: range-bound movement, time decay, and/or rising implied volatility. Let's say when you look at GOOG on September 20 the stock is at 460, around where it is today. Here is an example of what you can do: Buy 1 December 490 call and sell 1 October 490 call. On the put side, you can buy 1 December 430 put and sell 1 October 430 put. When you graph these trades using today's prices it looks like this:

Click here for a larger image.

This play will give us a good deal of room (the break-even points are $123 wide!). If the stock stays between the break-even points, and implied volatility does not decrease much, we should be okay. We are looking for a rise in the spread price of 10-15%. If we paid the debit mentioned above of $21.40, the target spread value would be between $23.50 and $24.60. Ideally, the trade would be entered between September 18 and 25^th. The expected announcement date is October 16, but this is not yet confirmed. It could be a few days earlier or later. But remember, we said we would be exiting before that. Assuming D-Day is October 16, you should be out of the trade no later than one week earlier - October 9^th.

TAKE NOTE! Whenever you place a trade, it's important to make sure you know the exact earnings date, because it will have a direct effect on your bottom line. Several reputable financial sites have made occasional mistakes in the past when posting the earnings dates. And mistakes will continue to happen. That's why it's best to go straight to the horse's mouth - the company itself - when confirming this date. Most company websites will have an "Investor Relations" area or something similar. If you cannot locate it, feel free to call the company and ask for the department by the same name. Once you have the date, mark it on your calendar! It's worth pointing out another important date. Expiration! The exit will be before October expiration. In fact it will be likely be before expiration week.  LMO: Let's move on.

What could cause the stock to travel outside of the break-even points? There are several things. For one, the company could make a pre-announcement about the report which could shake things up a bit. Overall market or sector volatility is another. This trade is not a guaranteed winner. You must understand the risks before entering any trade. Something else might cause the implied volatility of GOOG options to decrease. What does that mean? All of the options will lose value, which is overall bad for this trade, since we paid more money than we collected. If volatility decreases, the break-even points will become closer together, narrowing the profit range of which the stock must remain to make money.

In conclusion, this trade is called a Double Calendar, a type of income trade. When setting it up, the break-even points should extend beyond the short strikes and the middle part should be above the break-even line. This set-up may work for GOOG before earnings. If GOOG started moving outside the break-even points before October 9 or before the trade increased 10-15% profit, it would be best to exit. Until you fully understand this trade consider doing a paper trade so you can get used to how a Double Calendar performs as well as how GOOG stock and GOOG options behave.

--Dan Sheridan

Owner and Mentor

Sheridan Mentoring

All-Star Commentator

--Nicole Wachs

Director of Education

All-Star Commentator

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Dan's previous posts: Top Five Reasons to Trade FROs and Deciding When to Use Leap Calls

Nicole's previous posts: Liquidity of FROs and FRO Trading Requirements

For a list of previous All-Star Trades, please click here.

This comment and any market data included here were prepared on September 4, 2008.

Options involve risk and are not suitable for all investors.

Please read Characteristics and Risks of Standardized Options.

 

The theoretical return for this trade is not actual and does not guarantee future results.

 

While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.

 

Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.

 

Dan Sheridan has a professional business relationship with TradeKing.