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Facebook Is Starting To Get Liked Again After a Brutal Sell-Off

Selling a bull put spread to be a buyer of Facebook on further weakness

Shares of Facebook (NASDAQ:FB) are finally rebounding yesterday as shares neared major support. Facebook stock had fallen in seven of the previous eight days as investors elected to take risk off the table.

A person using the Facebook app on a smartphone
Source: Wachiwit / Shutterstock.com

FB is now back to levels last seen before releasing the company’s latest solid earnings report in late July.

The previous buying in Facebook may have gotten a little overextended, with shares reaching overbought levels as it traded at all-time highs.  In a similar fashion, the selling has now reached an extreme as well. Look for the Facebook stock to regain some lost momentum over the near term.

Facebook reported earnings on July 30 and beat handily on both the top and bottom line. EPS came in at $1.80 per share, well above analyst estimates of $1.40. Revenues also were a solid beat at $18.7 billion. Expectations were for just $17.4 billion.

Both daily average users (DAU) and monthly average users (MAU) came in higher than forecasts. Average revenue per user was $7.05 compared to an estimated $6.76. Total users across all apps was 3.14 billion versus 2.99 billion the previous quarter.

FB raced higher post earnings and traded to new all-time highs at $303.91 before dropping sharply. Facebook stock fell over 19% (nearly entering a bear market) before finally finding some footing.

This combination of higher earnings and an unchanged stock price leads to a lower EPS. This means valuations have become more attractive for Facebook stock.

The Technical Take on Facebook Stock

Facebook Stock Chart 1 Year
Click to Enlarge
Source: Thinkorswim® platform from TD Ameritrade

FB is looking decidedly more bullish from a technical perspective. Shares have completely closed the post earnings gap and bounced off major horizontal support at $245. The nine-day relative strength index (RSI) reached oversold levels but has since strengthened. Previous instances when this happened marked significant short-term lows in Facebook stock.

Moving average convergence divergence (MACD) got to the lowest readings of the past year but has turned higher. Momentum also was at the most extreme negative sentiment before it too popped sharply upward.

Facebook stock is trading at the steepest discount to the 20-day moving average in the prior 12 months. Each time this took place in the past year it inevitably led to a rally back to the average. Look for a similar scenario to unfold once again over the coming weeks.

 

How to Trade Facebook

The options market provides a way to collect premium now while positioning to be a buyer of Facebook stock at lower levels by selling an out-of-the money bull put spread. So rather than buy shares now, the spread strategy sets up to buy shares at a discount. In this instance, selling the $235 would be the level one would be obligated to buy Facebook stock. Buying the $230 put provides a built-in stop out level to define downside risk and reduce margin requirements.

Sell FB Oct $235 puts and buy FB Oct $230 puts for a $1 credit 

Option implied volatility spiked higher on the recent sell-off meaning options prices are more expensive. This means a bigger premium can be received for selling spreads. The maximum gain on the trade is $100 per spread with maximum risk of $400 per spread. Return on risk is 25%. The short $235 strike price provides a $19.75 (7.7%) downside cushion to the $254.75 closing price of Facebook stock.

Earnings are next due for Facebook in late October. The spread has an expiration date before then which removes any earnings-related risk

On the date of publication, Tim Biggam did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Anyone interested in finding out more about option-based strategies or for a weekly option and volatility newsletter can visit the Options and Volatility Newsletter website.


Article printed from InvestorPlace Media, https://investorplace.com/2020/09/facebook-is-starting-to-get-liked-again-after-a-brutal-sell-off/.

©2020 InvestorPlace Media, LLC