Expectations are running high for Google parent company Alphabet Inc. (GOOG, GOOGL) as it prepares to release its earnings results for the fiscal fourth quarter. The company has had an exceptional year, having benefited from greater online activity during the COVID-19 pandemic. However, there are signs that growth is slowing while inflation persists across the economy and market as a whole. Analysts forecast that Alphabet will announce $27.14 in earnings per share to accompany $72.1 billion in revenue. This represents a 21.7% increase in profit year over year, its slowest pace since the second quarter of 2020.
While Alphabet stock managed to outperform the market at large for the majority of 2021, as the market has turned to the downside at the beginning of 2022, Alphabet is outpacing market losses. Alphabet shares have fallen 6.4% year to date, while the S&P 500 Index has fallen 5.8%.
Option traders appeared to be positioned themselves for the Alphabet slide to pick up steam ahead of earnings. That's because there are a growing number of put options in the open interest, and implied volatility suggests that option traders are buying puts and selling calls ahead of earnings, reflecting a bearish sentiment.
Investors will keep a keen eye on Alphabet's traffic acquisition costs, a critical component of the company's overall cost of revenue. While Alphabet's revenue has grown quickly, it is important to keep an eye on how fast costs are rising as well. If costs rise faster than revenue, then the company's earnings growth may not be sustainable. Supply chain constraints could also increase costs for the company, placing further pressure on its bottom line.
- Alphabet shares have recently risen from an extreme low of the historical volatility range to an average range.
- The Alphabet share price closed just below its 20-day moving average.
- Alphabet has lagged its sector, which has been more or less in line with the market at large.
- Call and put pricing appears to be even ahead of the earnings report.
- Call and put open interest appears to be positioned for the price to fall in the near term.
Recent Sector Performance
Alphabet represents over 21% of State Street's Communications Sector ETF (XLC) holding by percentage. The sector recently has performed more or less in line with the market at large. Over the past month, XLC has fallen 5.4%, compared to a 5.8% decline from the S&P 500 Index. The chart below compares the recent performance of Alphabet and XLC with nine of the top sectors of State Street's S&P 500 Index ETF (SPY).
It's notable on this chart that the market appears to be rotating sectors in anticipation of the next phase of the economic cycle. The Federal Reserve has intimated several interest rate hikes in 2022 in order to combat inflation, and while the central bank has remained consistent in claiming that rate hikes will be small, investors continue to move their money into sectors that are considered safer havens for high-inflation environments, such as energy (XLE), consumer staples (XLP), and financials (XLF).
The worst performing sectors on this chart—technology (XLK) and consumer discretionary (XLY)—typically underperform during times of high inflation. Technology stocks tend to be high growth companies with large amounts of debt, and rising interest rates can slice into their bottom line. Alphabet, while not even a top ten holding of XLK, often finds itself lumped in with technology stocks.
Inside the Communications Sector
The communications sector is made up of companies that make communication possible on a global scale, whether it is through the phone or internet, through airwaves or cables, through wires or wirelessly. The largest companies in the sector are telephone operators, satellite companies, cable companies, and internet service providers.
With close ties to the technology sector, the communications sector could be considered a riskier investment during times of inflation, simply for the fact that investors could seek safe havens for their money. The chart below compares the recent performance of Alphabet with the top holdings of State Street's Communications Sector ETF (XLC).
It's notable on this chart that Alphabet has been outperformed by each of the other top holdings of XLC, with the exception of T-Mobile US, Inc. (TMUS). Despite comprising the largest of the holdings of XLC, the underperformance of Alphabet has yet to bring the entire sector down to its level. In contrast, several pure play telecommunications companies are outperforming the tech-oriented Alphabet.
Price Action and Option Details
An analysis of recent option activity combined with technical analysis of share price movement can grant chart watchers valuable insight into the overall sentiment toward Alphabet ahead of earnings. The chart below illustrates the recent price action for the Alphabet share price as of Monday, Jan. 31.
This chart highlights how Alphabet shares traded in a relative average range since the company last reported earnings in October 2021, highlighted by the channel in blue. The Alphabet share price finally broke to the downside at the start of 2022, falling below its 20-day moving average and trading at the extreme low of the volatility range. After pushing outside of the bounds of the volatility range, the Alphabet share price appears to have broken the downward trend and has recently closed closer to its 20-day moving average in the middle of the range, highlighted by the green arrow.
The purple bands on this chart are an extreme historical volatility range formed by four standard deviations of 20-day Keltner Channel indicators which depict price levels that represent a multiple of the average true range (ATR). ATR is a standard tool for illustrating historical volatility over time. These bands could be considered to represent the extreme ranges of option pricing. It's notable that these bands briefly widened in mid-December and have since remained wide despite the share price rising. This could mean that option pricing is growing ahead of the Alphabet earnings announcement.
Despite the Alphabet share price moving upwards from its extreme low, it appears that option traders are positioning themselves for the share price to decline in the near term. While recent trading volumes are split nearly even between calls and puts, the open interest skews bearish. That's because the Alphabet open interest features 77,000 calls compared to 164,000 puts. While a first look at these figures appears bearish, further analysis is required.
Over the past five days, total open interest has risen by 11.7%. During this time, the put/call ratio has increased by 5.9% and is well above its 52-week average of 1.6. Compared to its 52-week averages, call option open interest is weaker than usual, while put option open interest is higher than normal.
Out-of-the-money call options decline at a slower rate than out of the money puts; however, the implied volatility for these options is declining, while the open interest is rising. This indicates that traders are taking advantage of the elevated premiums ahead of earnings and selling positions in upside calls. This reflects a relatively bearish outlook toward Alphabet stock going into earnings.
The chart below illustrates at-the-money options expiring Feb. 18, highlighted by the solid green and red boxes. The green box represents the pricing that call option sellers are offering, and it implies a 36% probability that Alphabet shares will close inside this range by expiration. The red box illustrates the pricing for puts, with a 34% chance if prices go lower by expiration. The probability percentages are based on the current delta of each individual option.
Since the start of 2022, the Alphabet share price has declined at a faster rate than the market as a whole. Recently, the Alphabet share price rose from an extreme low of the volatility range and is trading just below its 20-day moving average ahead of earnings. Option traders appear to be taking the opportunity to sell call options ahead of earnings while option premium is at its highest, while also willing to pay these elevated premium prices to buy downside puts. This reflects an overall bearish sentiment toward the Alphabet share price ahead of earnings.