Defriend Facebook Inc Until After Earnings

Look for the recent rally in FB stock to stall out at $175

By Tim Biggam, InvestorPlace Contributor

Shares of Facebook Inc (NASDAQ:FB) are up 51% so far this year, far outpacing the 14.24% return for the S&P 500. Facebook stock is also approaching both a critical resistance area and an impending earnings report in two weeks. Both of these should give pause to further significant appreciation for Facebook stock. Given the recent run-up in shares, I look for FB stock to consolidate and trade sideways before earnings on Nov. 1.

Defriend Facebook Inc Until After Earnings
Source: Shutterstock

Expectations are for $1.29 EPS ($1.40 whisper number) and $9.64 billion in revenue. Facebook sports a current P/E of 38.9 and forward P/E of 26.2, both large premiums to the S&P 500. It is also at the high end of the recent valuation range over the past six months.

Previous instances when FB P/E multiples approached 38 proved to mark significant short-term tops in Facebook stock. Facebook has also joined the $500 billion club with a market cap of $506.8 billion. This makes FB the fourth largest company trading in the U.S. While size unto itself is not problematic, size as a function of growth most assuredly is a major hindrance.

The law of large number certainly applies to a mega-cap stock like Facebook. Growing at the same rate will become increasingly difficult, meaning P/E multiples will necessarily begin to contract in FB.

Facebook is trading right at the major resistance level of $175, which it has failed to break past in the prior two attempts. In my previous research piece on Facebook from Aug. 9, I suggested that FB stock appeared to have topped out at the $175 level. That proved to be prescient, as Facebook shares did indeed struggle at this key resistance point.

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I expect FB to remain subdued at this critical juncture in front of earnings.

FB Stock Trade

Buy FB Oct 27 $180 calls and sell FB Oct 27 $177.50 calls for a 50 cent net credit

Maximum gain on the trade is $50 per spread with a maximum risk of $200 per spread. Return on risk is 25%. The spread expires Oct. 27, which is before earnings on Nov. 1.

The short $177.50 strike is positioned above the major resistance level of $175 and provides a 1.7% upside cushion to the $174.52 closing price of FB stock.

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 [email protected] 

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