January 2016 has not been kind to equity bulls. Even the strong-performing stocks of 2015 have corrected 15% or more. Facebook Inc (FB) rose 30% in 2015 but has recently corrected 15% from its all-time highs.
So far this year, Facebook stock is down 10%.
Fundamentally, FB has respectable management who have proved they can execute on their plans. Facebook is at the forefront of mobile advertising and owns a large share of it. FB also is making a foray into the video display arena. Facebook CEO Mark Zuckerberg continues to show leadership with bold acquisitions that show tremendous potential. With more than a billion users to leverage, FB’s exponential growth in projects targeting those users should come easy.
Technically, FB stock sits on a pivotal level. On Wednesday, when the Dow Jones Industrial Average fell almost 600 points, Facebook stock bounced hard off the $89 per share mark — the same level as FB’s breakout point in July 2015. The $89 price point also served as the springboard for the October 2015 bounce.
Click to Enlarge I want to use this dip to go long Facebook stock into its earnings. In general, the short-term earnings price reaction is a coin toss, and I don’t like to risk capital in the face of this kind of risk.
So instead of buying the stock and risking thousands, I will use options to minimize my risk and maximize my gains.
Options are time-sensitive, so I want to set enough time on my trade to better manage the risk. I will implement this strategy via a pair of trades.
2 Trades on Facebook Stock (FB)
Trade #1: I sell one FB Apr $82.50 puts. For this I collect $3.50 per contract. This opens the downside risk if Facebook stock falls. If I get assigned Facebook shares, my break-even point would then be $79 per share. For that to happen, FB would need to fall another 18% from current levels. I can close this risk at any point between now and the expiration date.
Trade #2: I buy one FB Feb $98.50 calls. For this I pay $3.60 per contract. I only need FB to rally 2% before being in the money. For this combination trade to be 100% successful, I need FB stock to rise past my long calls by February. Since I am collecting enough premium to finance the purchase of the call position, any upward move in Facebook stock price will be pure profit. If FB stalls around this level then I lose nothing.
Selling naked puts is risky. I only do it when I am willing to buy the stock at the strike price sold. In this case, I don’t mind owning FB 18% cheaper than where it’s trading now. If I buy Facebook stock outright, I would risk $9,700 for 100 shares at current price. Any drop in price would result in immediate loss of capital. My strategy provides me with a 20% price buffer from here.
The U.S. markets are still tied to price action from China and the oil sector. So this leaves short-term open risk into Facebook stock price from negative headlines that are independent of FB’s fundamentals. Also losing the aforementioned $89 level could invite technical sellers. The likely target would then be around $82 per share.
The success of my trade depends heavily on the assumption that the macro health of the economy is tepid, and that we are not expecting another deep leg down in the U.S. markets.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.
