Facebook Inc. (NASDAQ:FB) announced a policy change in the way it prioritizes user feeds and Wall Street hates it. Facebook stock was down as much as 6% this morning, which these days is the equivalent of a mini-crash. That’s good news for options traders such as myself.
From time to time, we see major companies announce changes that shock investors. A few years ago we saw Netflix, Inc (NASDAQ:NFLX) go through a similar flub and management obviously dealt with it.
Decades ago The Coca-Cola Co (NYSE:KO) announced “New Coke” and that too was also a temporary setback. So, much like Netflix and Coke recovered from their management mistakes, Facebook will also shrug this off.
So today I am setting my trade so that I profit even if FB languishes depressed through earnings. Speaking of which, I expect a solid quarterly report and that the company financial metrics are still on track. I am confident that platform users will let management know quickly if they hate the new feed policy. If so, then I expect management to reverse it.
Fundamentally, FB is a premier company. Management has already proved that it knows how to make strategic acquisitions to further entrench themselves with their users. Speaking of which, with over a billion of them, I am confident that the company will continue to prosper for the long term. Their users are plentiful, active and engaged hours at a time and on a daily basis. This is leverage that is hard to mess up.
Technically, FB stock has recently broken out of a consolidation zone set between $176 and $180 per share. This morning’s dip brings it back to that zone. Often enough we see prior resistance become forward support. So I am confident that the bulls will fight for it. Neither side usually is willing to let such areas of contention go without a fight. This creates a stall in the zone, which is advantageous to the bulls.
Holding the line is the first step on a headline dip; the bounce comes later. However, with stock markets at all-time highs for so long I am more confident in support than upside potential. Meaning I am not as confident aiming for a higher target for Facebook stock as I am in knowing that there will be support below. So I am not willing to risk $180 per share here and without any room for error expect a rally to profit.
Instead, I will use options where I can bet against unlikely downside scenarios. If markets, in general, don’t correct, I am comfortable owning FB shares at a discount from here. So I will sell downside risk against support then let time do the work for me.
Facebook’s price-earnings ratio is 35, so it’s not bloated considering its growth and margin levels. Wall Street experts agree since the stock is still trading 15% below the average price target, so they too see its potential.
In this animal spirited stock market, dips are scarce. So when we get one in a quality stock like FB, I go long.
The Trade: Sell FB Feb 9 $157.50 put. This is a bullish trade for which I collect $1 to open. I have an 85% certitude that I will retain maximum gains. But if the FB stock price falls below my strike then I own it. I would then need to manage off my breakeven point of $156.50.
Selling naked puts is daunting, however, especially near all-time high stock markets. Those who want to mitigate that risk can sell spreads instead.
The Alternate Trade: Sell FB Feb 9 $160/157.50 credit put spread. The spread has the same odds but would deliver 12% yield on risk.
Today’s trade doesn’t need a rally to profit (although it would benefit from one). I merely need FB to hold its support for the next few months.
I am betting that the value in the stock will prevent sellers from taking it too far. It is important to know that if they do, then I want to own the shares at a discount from here.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.
Get my newsletter for free here. 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. You can follow him as @racernic on twitter and stocktwits.