Heading into year’s end, social media stocks like Facebook (FB) and Twitter (TWTR) are being hit with some profit taking.
And why shouldn’t they be?
As a result of a massive December rally — especially in Twitter — both hot social stocks became massively overbought and in dire need of a pullback. Before succumbing to gravity, TWTR was up 80% while FB stock was up a more modest 25% for the month.
The recent dip in FB stock is a welcome development for traders like myself wary of chasing stocks that have already ascended into the stratosphere. Indeed, from a risk-reward perspective, both stocks are quite a bit more appealing now versus a short week ago.
However, of the two social media darlings, Facebook stock certainly has less volatility and arguably a more sustainable uptrend, making it the superior choice for traders with a more conservative tilt. So, let’s break down the FB stock chart and piece together a high-probability options play.
Three developments of note stick out on Facebook’s stock chart:
- The recent bout of profit taking has lowered FB stock to a key price level near $53.50. The principle of polarity states that old resistance tends to become new support. Earlier in Facebook’s ascension, the $53.50 zone provided resistance, so now that we’re testing it from the topside, there is a fair chance it becomes support. Even if FB stock probes beneath this area, other potential support levels — such as the 20-day moving average — will come into play.
- The three-day drop in FB occurred on average-to-light volume, suggesting an absence in any major selling pressure. Light-volume selloffs are easier to overcome because they lack the firepower of institutional selling, which tends to continue to weigh heavily on the stock, thwarting future attempts to rally.
- So far, Tuesday’s trading session is taking on the form of a bullish harami candle, suggesting the end of the recent pullback and the beginning of its next upswing. For those otherwise unfamiliar, this Investopedia definition does the trick: “A bullish harami occurs when a large candlestick is followed by a smaller candlestick whose body is located within the vertical range of the larger body. In terms of candlestick colors, the bullish harami is a downtrend of negative-colored (red) candlesticks engulfing a small positive (green) candlestick, giving a sign of a reversal of the downward trend.”
To profit from a turnaround in FB stock, consider selling the Feb 46 put for $1.07. By shorting this out-of-the-money put, you’re basically betting FB will remain above $46 by February expiration. The max reward is limited to the initial $107 credit received at trade inception.
By selling the put, you obligate yourself to buy FB stock if it should fall beneath $46 by expiration. Should this occur, your cost basis would be $44.93 ($46 – $1.07). If you’re not a willing buyer of FB at this level, you could simply exit the trade by buying back the put if FB falls beneath $46. The loss should come out to about $260.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.