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Investors Weigh Google Futures as Earnings Loom

It's always been difficult to trade Google ahead of its earnings report, but this quarter it's harder than ever.

Google Headquarters
AP
Google Headquarters

Investors are worried that the Web search company's once explosive growth could slow dramatically in the weak U.S. economy.

Yahoo is said to be seeking some sort of partnership with Google to fend off an unwanted takeover by Microsoft.

And to complicate the picture further, Google's April options expire Friday, one day after Google is due to report results, adding another layer of unpredictability to an already high-priced and volatile stock.

Options activity since the start of the month has been leaning on the call side, indicating optimism about the upcoming earnings, but some contrarians suggest buying Google puts instead; others urge investors to hedge their bets against a big swing in either direction.

"Odds are that Google shares will go lower on earnings," said Ryan Detrick, analyst at options research firm Schaeffer's Investment Research in Cincinnati, Ohio. "So we would recommend buying April puts."

At the heart of uncertainty over Google is a fierce debate among analysts over whether its rapid revenue growth has entered a long-term slide from levels near 100 percent three years ago, accelerated by economic weakness.

Bulls argue that Google is poised for strong new growth in the online brand advertising market and the emerging mobile phone ad business.

With Microsoft's bid to buy Yahoo and create a more formidable rival to Google, and a 39 percent decline in Google shares from record-levels just six months ago, this uncertainty has taken on added significance.

"I think this earnings report will be one of the most important releases from Google in awhile," said Credit Suisse equity derivatives strategist Sveinn Palsson. "There is a lot of debate on how Google will fare in a slowing U.S. economy."

Wall Street analysts expect Google's first-quarter revenue to grow 40 percent over the year-earlier quarter, according to Reuters Estimates.

Profit is expected to grow 26 percent, held back in part by accounting changes and acquisitions.

Yet a wide gulf has emerged between what analysts say Google is worth over the next 12 months and what investors are ready to pay.

The average estimate by 27 analysts who have set price targets on the stock is more than $650.

While 29 brokers have some sort of buy rating on Google, just four rate the stock's potential as neutral and no analyst recommends a sell.

Still, Google shares have been rangebound since February.

As of Friday's close at $457.45, the shares were down 34 percent since the start of 2008 and down 39 percent from nearly $750 in November.

The stock was down $4.44 or 1 percent to $453.01 in afternoon trade on Monday.

Weighing Options Strategies for Google

Goldman Sachs notes Google's shares have moved an average of plus or minus 5 percent over the last eight quarters on earnings day alone.

The stock fell more than 9 percent after year-end results in January, which were hurt by rising costs and slowing advertising sales growth and the added punch that came from Microsoft revealing its industry-shaking bid to acquire Yahoo.

This Friday, April options go off the board and stop trading at the close, which could exaggerate what happens to Google's implied volatility.

Implied volatility measures the magnitude of projected stock movements based on option prices.

Implied volatility for the front month options was climbing to about 70 percent near midday on Monday and could top over 80 percent by Thursday, said Randy Frederick, director of derivatives at Charles Schwab in Austin, Texas.

A high level of implied volatility indicates a greater degree of uncertainty about Google's future share price in the aftermath of its earnings.

During the last earnings report in January, front-month implied volatility increased from the high 30 percent range in the days heading into the earnings report to over 50 percent just before Google reported, he said.

Some investors may be waiting until the last minute to snap up April puts and calls on the Silicon Valley stock, as the options would normally become less expensive as the time before April options expiration dwindles.

"As the time value erodes and the April option prices become cheaper, this could entice more buyers to speculate on Google's earnings," said options analyst Brian Overby.

"This may drive up Google's implied volatility and will make the shares even more volatile than normal around earnings," said Overby, senior options analyst at online brokerage TradeKing in Boca Raton, Florida.

In an April 9 research report, Goldman Sachs strategists suggest owning April straddles or strangles — option strategies that combine both puts and calls — ahead of the earnings to catch a potential market or stock-specific move.

For investors who believe Google shares are poised to rebound, Credit Suisse Palsson recommends buying a June $480 call or, alternatively, a June $480/$550 call spread that would return about 12 percent if Google went above $550 through June.

Then again, this could be an earnings period of many negative surprises.

For Google shareholders who don't want to sell the stock but can't stomach its volatility, Frederick advises buying an April collar.

A collar is a spread strategy that combines a covered call and a protective put, which gives the right to sell the stock at a given price and time.

"This strategy works well if you are concerned that the stock may trend down in the short run but you believe the long term prospects are favorable," he said.