Facebook Inc (NASDAQ:FB) is due to report earnings May 3, and analysts expect a fairly healthy beat on earnings. FB stock is priced accordingly.
Wall Street’s expectations are for $7.85 billion on the top line and $1.12 per share on the bottom line, with a whisper number sitting at $1.21 per share. And unless Facebook absolutely crushes those numbers, I expect shares to struggle to head higher in the days and weeks following the report.
No one disputes that Facebook has become the dominant player in the digital space. InvestorPlace contributor Lawrence Meyers drills down deeply into the numbers in a recent story that shows just how impressive the fundamentals are. My major concern with FB stock is the company’s ability to maintain such a torrid growth rate as the company becomes bigger and bigger.
Facebook is now the fifth largest U.S. company by market cap, with a valuation exceeding $415 billion. Of course, Facebook stock also sports a bloated price-to-earnings ratio of 41, and a very rich price-to-sales ratio of 15. While these ratios could be justified when FB was smaller, they’re becoming awfully optimistic for this now-behemoth-sized company.
This is especially true given slower U.S. rates and space for ads reaching a saturation point.
Facebook has most assuredly put in a solid rally so far this year, rising over 25% year-to-date. After bouncing of the major $115 support level, FB stock has become overbought on a nine-period weekly RSI basis. Whenever shares have reached overbought levels like these in the past, it proved to signal a significant short-term top in the stock.
I am certainly not a perma-bear as my bullish article on FB stock from Jan. 4 will attest. But price ultimately does matter, which is sometimes forgotten in an aging momentum-based rally. With Facebook now stretched on both a technical and fundamental basis, I look for shares to begin to consolidate at current levels.
As the old trading adage states; “Trees don’t grow to the sky forever.”
How to Trade FB Stock Here
To position for the rally in Facebook stock to begin to temper, a short call spread makes sense. Implied volatility (IV) is heightened in front of earnings so option premiums are richer, favoring option selling strategies.
Buy the FB May $155 calls and sell FB May $150 calls for a 80-cent net credit.
The maximum gain is $80 per spread, and the maximum risk is $420. Return on risk is 19%. The short $150 call strike provides a 3.5% upside cushion.
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.
