Shares of Facebook Inc (FB) have been mired in a trading range after the earnings report on April 28. I look for this period of consolidation to end after the Memorial Day weekend, with Facebook stock ultimately breaking out to the downside.
As the chart shows, $116 is a critical support level for FB stock. Facebook stock failed to break this level in both early February and late March before finally piercing through following earnings on April 28. Since then, FB has repeatedly tested and held this $116 level. The 20-day moving average looms just overhead at $117.77, with Facebook stock breaking below this average for the first time post-earnings.
As the sixth-largest U.S. stock by market cap, Facebook enjoys a lofty perch among the megacap stocks. With a price/sales ratio still above 17, FB is valued at a huge premium. Compare that to number two market cap stock Alphabet Inc (GOOG, GOOGL), which trades at “only” 6.5 times sales. I look for this valuation to realign to some semblance of sanity, with FB stock heading lower.
The options market has become extremely complacent regarding Facebook, a reliable bearish contrarian indicator. Implied volatility (IV) is now in the 12th percentile over the past year, and at the lowest level since last December. This is another way of saying option prices in FB have become very cheap on a relative basis.
In my previous article on Facebook stock from May 5, I thought FB was in for a period of sideways action and recommended a short call spread strategy, which proved prescient. With implied volatility now at lower levels, I favor positioning with long volatility option trade structures.
I think FB will hold the $116 support through the Memorial Day period but ultimately resolve itself to the downside. The nice thing about option strategies is that you can tailor a trade to fit your particular outlook based on the timing, direction and magnitude of the move.
So to position for this scenario, a put calendar spread makes probabilistic sense. Selling a short term put to position for support to hold for a few weeks, while buying a longer-term put to position for the ultimate break.
FB Stock Trade
Buy the June 17 $116 put and sell the June 3 $116 put for a $1 net debit.
The maximum risk on the trade is $100 per spread. The maximum gain is achieved if FB closes near $116 on the June 3 expiration. The lower support area of $108 would be a viable target for profit taking.
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
