Facebook will be announcing earnings after market closes on Wednesday, January 30, 2013
Facebook is a wild company. The stock has performed well in the last 3 months but is flat on the year, and down 20% from its IPO pop. It is a way to play Social Media, Internet, Technology and Advertising.
Here we will discuss an idea of how to play the earnings release.
The current expected move for the stock is about $4. That puts the stock at either $26 or $34 by February 15th option expiration day. The way to determine the expected move is by adding the price of the two “at the money” options together. With the stock currently trading at $30 a share we can take the $30 call plus the $30 put and that gives us $4.00.
Here is the chart for FB
We can read the chart two ways.
The bulls say: This stock is recovering nicely from the IPO sell off, it is currently consolidating for its next leg up. It met the psychological resistance level of $30 and is ready to break out to a new high. They are now expanding their powerful data bank of social graph information. and they did a great job monetizing mobile last quarter. It is only a matter of time before the stock hits a new 52 week high and we see $50 a share.
The Bears say: Look at the P/E ratio, enough said! A trailing P/E of 257 and a future one of 47, where can they generate new earnings growth? They have saturated the market and now user growth is going negative. $30 is the peak and we don’t go higher.
The options trade:
Instead of going long or short the stock there is an option trade we can do, it is called a vertical spread. I will give the example with Calls but the exact same thing can be done with Puts.
A vertical spread is when you buy say the $30 call for $2.00 and then sell the $32 call for $1.00. This will cost $1.00 and if the stock moves above $32 a share by the Feb 15th expiration you will make $1, a gain of 50%.
How did that work? The difference between the $30 strike price and $32 strike price is $2. Assume the stock is at $32 on expiration date, your $30 call will be worth $2 and your $32 call will be worthless. Because you purchased the $30 call and sold the $32 call, you need to keep calculating the difference in price between the two.
Maybe times in a vertical spread trade you do not need to wait until the options expire to lock in your profit. If Facebook moves up to $32 a share over night, then within a few days you will be able to sell this option combo for $2.00.
So why implement a vertical spread?
It is very tempting for many people to buy the $30 call for $2.00 and hope the stock goes to $36 a share and your call option will triple. The problem with buying calls before earnings releases is that they are very expensive because implied volatility is high. A vertical spread like this scenario, provides a chance of making 2X your money and you do not need the stock to move too high.
Of course there are still risks. When trading options, if you pick the wrong direction of the move, then both of your options become worthless. A vertical spread limits the potential profit when comparing it to just buying a Put or Call straight out, but at the same time still gives you potential for a huge return if the stock moves enough to make both options in the money.