If You Want to Play Facebook Earnings, You’ll Need Guts

by Joseph Hargett | July 24, 2013 9:10 am

Social media giant Facebook (FB[1]) will step into the earnings confessional after the close of trading this afternoon for only the fifth time since the company went public back in May 2012, and the trading public is showing signs of optimism.

For the record, Wall Street analysts are expecting a second-quarter profit of 14 cents per share, up 14% from 12 cents per share in the same quarter last year. Revenue is seen growing 37% to $1.62 billion. Meanwhile, the Q2 whisper number for Facebook earnings arrives a penny higher at 15 cents per share.

Historically, FB has had trouble hitting Wall Street’s targets. During the past four reporting periods, Facebook has only topped expectations twice, matching one and whiffing the consensus estimate twice.

But investors will be looking at more than just Facebook’s second-quarter bottom-line figures.

For one, subscriber growth will be key for the company, particularly on the mobile front. Last quarter, Facebook reported that it added 751 million mobile subscribers, a jump of 54% over the prior year. You might remember that FB shares have been hit pretty hard in the past when mobile revenue fails to live up to expectations.

Speaking of Facebook’s mobile presence, investors also will be looking for signs of the company’s planned launch of video ads. News of the ads leaked in April, with reports indicating that Facebook could charge as much as a cool $1 million for the 15-second spots. News on this front could be a game breaker for Facebook’s revenue stream.

Turning to the sentiment front, we find a wealth of optimism backing Facebook heading into tonight’s quarterly report. In the brokerage community, FB has attracted 27 “buy” ratings, 11 “holds” and just two “sells.” Meanwhile, the 12-month consensus price target rests at $32.26 — a healthy premium of about 23% to Tuesday’s close.

The bulls really emerge on the options front, however. Currently, FB sports call open interest of 673,640 contracts in the July/September series of options, compared to put open interest of 315,889 contracts. The result is an extremely bullish put/call ratio of 0.47, with calls more than doubling puts during this period.

Surprisingly, attitudes are slightly more tempered in the soon-to-expire weekly July series, where the put/call open interest ratio comes in at 0.58. In other words, while options traders are expecting FB shares to rally, they don’t appear to be wagering as heavily on an immediate knee-jerk reaction to tonight’s quarterly report.

Just where are these call traders placing their bets? In the weekly July series peak call open interest totals 24,897 contracts at the 27 strike, followed by 23,689 contracts at the 30 strike. Given recent activity, it is possible that more than a few options traders have opened up bull call spreads, or ratio bull call spreads (where you sell deeper out-of-the-money calls in a greater ratio than purchased calls) , at this strike.

That said, the bullish situation gets a more than a little exuberant in the monthly August series, where the put/call open interest ratio comes in at 0.33. In other words, front-month call open interest outstrips put open interest by a factor of three. The 30 strike is once again the most popular, raking in 74,219 call contracts, followed by the 27 strike, with 40,315 calls.

FBChart 300x247 If You Want to Play Facebook Earnings, You'll Need Guts
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In addition to expectations that Facebook is improving its mobile revenue streams, the stock’s short-term technical performance might also be driving optimism toward the stock. While FB has been driven steadily lower by its 10- and 20-week moving averages for the better part of 2013, the shares currently are in rally mode after bouncing from support at $22.50 in June.

In fact, the stock is poised to close its second week above the aforementioned trendlines since February.

On a daily chart, however, FB is showing signs of fatigue. The shares are pulling back from overhead resistance near $27, as their 14-day RSI skirts the edges of overbought territory. Additionally, FB’s 50- and 200-day moving averages completed a bearish cross back in mid-June. This technical formation does not bode well for FB, and could lead many technical traders to hold off on buying into the current short-term bounce.

Returning to the options pits, July weekly implieds are pricing in a potential post-earnings move of about 8% for FB. This places the upper bound on an immediate rally near $28, while the lower bound lies near $23.91.

Traders looking to play Facebook earnings will want to proceed with caution. The stock seems highly volatile at its current perch, and FB has a history of disappointing with its quarterly reports. In fact, the stock’s average three-day move following the past four quarterly reports is a loss of 4%, with the FB averaging a loss of more than 6% one week later. As such, traders might be better off holding their bets until after Facebook releases its quarterly report.

On the other hand, those traders with a higher tolerance for risk might want to buck the bullish sentiment trend and bet on FB’s historical post-earnings performance by opening up an August 24/27 bear put spread.

At the close of trading on Tuesday, this spread was offered at $1.33, or $133 per pair of contracts. Breakeven lies at $25.67, while a maximum profit of $1.67, or $167 per pair of contracts, is possible if FB closes at or below $24 when August options expire.

As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.

Endnotes:
  1. FB: http://studio-5.financialcontent.com/investplace/quote?Symbol=FB

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