by Tyler Craig | October 29, 2013 1:49 pm
With Apple (AAPL) earnings now in the rearview mirror, traders have turned their collective attention to one of the hottest momentum names of the year — Facebook (FB). With the social media darling recently up as much as 100% for the year, and 60% since its last earnings release, expectations are running high into tonight’s number.
Click to EnlargeHere’s how you can play the release to your benefit.
The groundswell in uncertainty surrounding the earnings event has driven implied volatility for FB options to its highest levels since the company’s first earnings release as a public company back in July 2012. The elevated price for option contracts suggests the market is expecting a large jump in response to earnings.
While guessing the direction of the gap is a mere coin flip, we can at least gauge the magnitude of the move as priced in by the options market.
One popular method for gauging expectations consists of looking at the price of a straddle using weekly options. With FB currently trading at $49.50, the net cost for purchasing a weekly Nov. 1 49.50 put and 49.50 call is $6.15. This means the long straddle is pricing in a $6.15 move up or down between now and Friday. By dividing $6.15 by the current stock price of $49.50, we can translate the expected move into a percentage of plus or minus 12.4%.
Click to EnlargeOf course that 12.4% range is what is expected between now and the end of trading on Friday — two full trading days after the earnings gap. Throw it all together and it’s fair to say the market is expecting something around a 10% jump.
If you like Facebook longer-term and view any kind of post-earnings dump as a buying opportunity, consider selling out-of-the-money November weekly puts. By selling a put, you obligate yourself to buy 100 shares of stock at the strike price if the stock falls enough and the put sits in-the-money at expiration. If the stock remains above the strike price, the put will expire worthless — allowing you to pocket the initial credit received at trade entry.
Selling puts is also an effective way of exploiting the high implied volatility levels since it allows you to capture the extra money being pumped into option premiums ahead of earnings.
To enhance the probability of profit, consider selling the Nov. 1 43 put for 63 cents or better. By going all the way down to $43, the stock would have to gap more than the expected 10% for you to lose money at expiration. All in all, the short 43 put offers an attractive play if you’re a willing buyer of FB in the $42.50 range.
At the time of this writing Tyler Craig had no positions on any of the aforementioned securities.
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