by Tyler Craig | August 23, 2013 2:22 pm
The fickle nature of investors has been on full display since Facebook’s (FB) debut as a public company.
At first, Facebook fever swept through the Street generating a groundswell of demand for its much-anticipated IPO. The day of its launch, Facebook stock prices opened at a scorching $42 (and got as high as $45), giving the company an uber-rich valuation north of $100 billion.
Within the first four months, though, the massively hyped social media star plunged as much as 58% finally bottoming at $17.55.
Click to Enlarge Of course, those who bailed near the bottom and never returned are now singin’ the blues. After Facebook’s epic recovery — supercharged by its recent upbeat earnings announcement — it now sits a stone’s throw from its IPO price.
With the first line of Facebook stock investors finally being made whole, some might be wondering what to do next. Let’s head to the options market to explore a few ideas.
Throughout the exercise, we will assume we’re using an investor who purchased 100 shares of FB at the $42 opening price.
While all FB shareholders are rejoicing at its miraculous resurrection, some are no doubt wanting to get the heck out once it returns to their purchase price. These participants in the Wall Street carnival are dissatisfied and downright dizzy after their time on the Facebook coaster and wish to depart in search of calmer attractions.
Instead of simply setting a sell limit order at $42, these investors ought to consider selling an Oct 40 call for $2.20. In exchange for obligating themselves to sell the stock at $40, these antsy-to-exit shareholders are compensated by being able to pocket the $2.20. If FB sits above $40 at expiration resulting in assignment, the stock will be taken away at an effective sell price of $42.20. The covered call accomplishes the original goal of exiting at or above the original purchase price ($42), but only requires the stock to be above $40. In other words, using options, we lowered the breakeven of the position from $42 to $40 — a reduction of about 5%.
Diehard shareholders content with sticking with the stock but not wanting to experience another outsized drop in the stock might consider buying put options. The strike price and month selected depends on the desired length and cost willing to be paid for the insurance. If you’re seeking protection through year-end, you could purchase the Dec 40 put for $3.50. The long put provides the right to sell your Facebook stock at $40, which reduces your downside risk from $4,200 (100 shares x $42) to $550 (100 shares x [$42 – $2] + $350).
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
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