To The Moon

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Playing catchup in AI

Have you ever seen a football play where the offense snaps the ball while the defense is still milling about, not set? This is a terrific analogy for Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) position when ChatGPT became the rage. Luckily, being caught flatfooted on one play does not mean the game is lost.

Many commentators and investors soured on Google after Microsoft invested billions in ChatGPT to bring its technology to Bing. But the demise of Google Search is greatly exaggerated. According to the latest data on Statista, Google Search held 85.5% of the desktop search market compared to 8.2% for Bing as of March 2023. Google's share is slightly higher than it was upon ChatGPT's release.

Alphabet is urgently pushing its artificial intelligence (AI) and generative chatbot technology to market with Bard and PaLM2, its next-gen large language model. It also combined its two AI research groups, Brain and DeepMind, into one dubbed Google DeepMind. It has some of the highest-regarded minds in the industry in control.

Who says stock splits don't matter?

Write any analysis about a company splitting its stock, and "stock splits don't matter" is a common response. While the splits don't change the company's value, they open up opportunities for investors to generate cash using options.

Options are sold in lots of 100 shares, so when Alphabet traded for $2,000 a share, one would need a $200,000 position to sell a call option. Now, we only need a $12,000 position - much more doable.

Without further ado, here are two ways to generate yield from a growth stock using options.

#1: Sell covered call options

For investors having at least 100 shares, selling out-of-the-money (OTM) covered calls has several advantages, such as:

1. Generating cash;

2. Mitigating short-term risk if the stock falls; and

3. The ability to reinvest the cash into other money-making vehicles (like other stocks or interest-generating savings).

When we sell an OTM call option, it gives the buyer the right to purchase the stock at the strike price on or before the expiration date, and we pocket the premium. If the stock does not rise above the strike price, we keep the premium free and clear. Congratulations! We have just generated yield from a growth stock.

If the stock goes over the strike, we can buy back the call at a higher price or let the shares go for the strike price. The best play here is to repurchase the call and then sell another one for a later date and at a higher strike. This way, we recoup the premium and also keep the shares.

Here is an example: On May 22, a $145 October 20, 2023 Call netted $3.25 per share or $325. The same option can be repurchased at the time of this writing for just $0.98, netting the seller a $226 profit for each option. This amounts to ~2% yield in under two months. Doing this several times during the year creates a juicy yield.

We can pocket this now or hold out longer for a larger potential profit. I have an 80% rule: I repurchase it and lock in the profit once a covered call has reached an 80% gain. This opens up the ability to sell another call at a higher price when the stock has a short-term rally and mitigates the risk of something crazy happening before the expiration date. In the case above, I create a limit order to repurchase the option for $0.65.

The timing is right for this strategy since analyst downgrades and negative sentiment will likely keep the stock from rising precipitously in the short term.

#2: Selling cash-secured put options

This strategy takes advantage of Alphabet's relatively strong performance (despite the negative sentiment) and prolific stock buyback program. Alphabet is still extremely profitable and generates oodles of cash from operations, $90 billion over the past twelve months.

In addition, the company increased the buyback program by $70 billion in April and has repurchased $61 billion over the past twelve months.

Both of these items support the stock price and make selling put options an attractive way to generate yield.

A put option gives the buyer the right to sell a stock for the strike price on or before the expiration date. For instance, if you sell a put option for $100 and the price stays above this, you keep the premium free and clear. If the stock price drops to $90, you still keep the premium but must purchase the shares for $100. Typically, we would repurchase the option at a loss rather than allowing the stock to be assigned.

A $105 November 17, 2023, put sells for $2.40 now, netting the seller $240 per option. The stock would have to fall 15% to $102.60 for the trade to lose money. This seems unlikely. Plus, at $102.60, many of us would add to our position anyway, making this option plan an excellent bet.

Selling puts is riskier than selling covered calls. If the stock were to crash due to a catastrophic market event or an accounting scandal, the seller could lose a bundle. This scenario is unlikely but not impossible.

The bottom line

Rumors of Alphabet's decline are greatly exaggerated. The company is a cash flow machine, has a stranglehold on Search not likely to be lost anytime soon, and Google Cloud is posting impressive growth. Management's commitment to cost controls and the aggressive buyback program will benefit long-term investors. Meanwhile, income-producing strategies, like the two above, are terrific ways to generate yield. $Alphabet(GOOG)$

RESOURCE: SEEKINGALPHA