FB – The Dip in Facebook Stock Looks Inviting

by Tyler Craig | December 31, 2013 1:33 pm

FB – The Dip in Facebook Stock Looks Inviting

Heading into year’s end, social media stocks like Facebook (FB[1]) and Twitter (TWTR[2]) 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.

FBstock 1024x788 FB   The Dip in Facebook Stock Looks Inviting
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Three developments of note stick out on Facebook’s stock chart:

  1. 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.
  2. 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.
  3. 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[3]: “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.

Endnotes:
  1. FB: http://studio-5.financialcontent.com/investplace/quote?Symbol=FB
  2. TWTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=TWTR
  3. this Investopedia definition does the trick: http://www.investopedia.com/terms/b/bullishharami.asp

Source URL: http://investorplace.com/2013/12/fb-stock-options/
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