After failing to break out to fresh all-time highs at the end of March, shares of Facebook Inc (FB) finally had the long-awaited pullback. FB dropped 7% from the $116.99 high on March 30 to the $108.77 low on April 11 before finding support at the $109 level.
While I have been somewhat skeptical in past articles regarding the ability of Facebook to head appreciably higher, I think the recent price action in FB portends a short-term bottom in FB stock.
As seen in the chart below, FB stock held the critical $109 support level, bouncing off this level on both Monday and Tuesday.
Yesterday’s price action, with FB failing to make a new low and subsequently rallying to close higher on the day, many times signals a reversal day.
Click to Enlarge Bollinger Band analysis also supports the short-term bottom thesis, with the $108.99 low on FB yesterday coinciding with the lower Bollinger Band level of $109.02.
The previous two forays towards the lower end of the Bollinger Bands were both significant lows in FB stock.
Certainly valuation concerns always surround a growth stock like FB, and I alluded to these concerns in my previous post from Feb. 2. But while longer-term investors should be more valuation driven, short-term traders need to focus more on the technical aspects and price action.
Click to Enlarge Listening to what the market is telling you and the ability to adjust your previous stance is critical to long-term trading success.
So although longer term I still think FB stock will have a difficult time moving appreciably higher past the all-time high, for the short-term, the market is telling me that a 7% pullback from the recent highs may be it.
How to Trade FB Stock
To position for the $109 support level to hold, I would look to sell an out-of-the-money put spread on FB. With earnings due after the close on April 27, I want to have the expiration prior to that date to avoid the earnings risk.
Specifically, I am buying the FB April 22 $106 puts and selling the FB April 22 $108 puts for a 40-cent net credit. The maximum gain is $40 per spread with the maximum risk being $160 per spread. Return on risk is 25%.
I would look to cover the position on a meaningful break below the $109 support level while letting the spread expire worthless and keep the initial $40 credit if FB remains well behaved.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
