Generate a 113% Gain As Facebook Faces The Music

You couldn’t ask for a clearer picture of what moral outrage can do to a company’s stock than Facebook’s (FB) fourth-quarter stock chart.

The company has been in the hot seat all year, from its Cambridge Analytica scandal to this week’s New York Time’s piece over the company essentially selling users’ data to other tech giants like Amazon, Microsoft, and Netflix.

Shares have fallen 40% since this summer. It has been one of the leading reasons why the Nasdaq is officially in bear territory.

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Ordinarily, when a company falls so far, so fast, my immediate reaction is to ask, has anything changed at the core of its business?

If the answer to that is no, that can present a nice buying opportunity. As they say, crisis is opportunity.

On the surface, Facebook seems like the perfect rebound play. During its third quarter, it brought in more revenue, income, and users. Its taxes were lower than expected, and its platform was being used daily by more than 2 billion people around the world.

This predates some of the more recent scandals, with the announcement coming at the end of October. But the company was already “suffering” through plenty of negative press at the time.

However, there’s a big reason why Facebook’s business is not the key factor in determining when a bounce will come: no one trades it for the advertising revenues.

Few investors really even care about its earnings per share figures or operational margin anymore. FB has gone from a college forum to the most used service of any kind in the world. It has Instagram for its high-growth appeal, WhatsApp for messaging and even Oculus VR for next era gaming.

People buy Facebook shares because of momentum and to have their hand in the tech pie… more specifically, those looking to own FAANG stocks (Facebook, Apple, Amazon, Netflix and Alphabet’s Google).

Now, before we get to its very real problems going forward, it must be noted… Facebook is more likely than anything we know to eventually rebound.

Those above fundamentals of stability and growth, as well as its now diversified portfolio of apps and services with millions of users,  are going to be long-term drivers.

But looking at how to trade a company like Facebook, you have to look to the short-term prospects. And they are not good.

There are three major reasons Facebook’s investors will continue to leave the company in the short term.




Facebook’s Fall Should Continue

First, Facebook represents one of the biggest losers on Wall Street for 2018. This is the time of year, investors shed the bad and buy the good.

They reposition their portfolios this time of year. In that mixing around of new position sizes, companies that have done so terribly in 2018 are likely to get culled. Some contrarian investors might buy for this reason. But the rest of the investment community won’t.

Just today, following the company’s terrible opening trades, an analyst for Needham cut her price target on FB by more than 20%. More analysts will use this time to reevaluate just how fast Facebook might be able to recover. And they’ll find the same negative conclusions as Needham’s.

The second reason Facebook is going to continue slipping is because of what we mentioned above. FAANG is in trouble. Last year, everyone wanted to own a piece of each of these tech giants. Now, no one does.

As Kevin Landis from Firsthand Technology Opportunities put it, “This was a year when at the start of it you had to own the FAANG names and at the end of it you don’t want to own any of them.”

He’s not alone. You can go right down the list to see just how each have dropped. Apple is down 35% from its peak. Amazon is down 32%. Netflix, 42% and Alphabet, 23%.

It’s clear, the FAANG is breaking up. Remember the last great acronym of investments, BRIC? Well, you don’t read about how Brazil, Russia, India and China are great places to put your money anymore.

Finally, there’s the new Democrats with control over House subpoenas. While many in D.C. remain clueless over how tech works, there are a lot of new faces with a lot less history of Silicon Valley money in their pockets.

The House is going to keep pressuring the likes of Mark Zuckerberg on these privacy issues. The longer that remains in the news, the longer this downward pressure will remain for Facebook shares.

So, how do you play it?

A Strategy For Short Term Weakness

A bear call spread is one where a trader sells a call option at or near the price of the underlying security he sees as weak in the short term. He then buys another call with a higher strike price.

This results in a net credit to his account, since the sold call will have a higher premium than one further out of the money.

The credit that hits his account at the beginning of the trade is the maximum profit potential for the trade. He gets that right up front. He gets to keep it if shares of the underlying stock fall during the duration of the option contracts.

The maximum risk for this trade is found by taking the difference in strike prices between the two calls and subtracting out the credit the trader received.

The trade would turn to a loss if shares rose during the duration of the trade. Let’s take a look at a specific example of a bear call spread on Facebook.

A Specific FB Trade on its Short Term Weakness

If you sold a January 18 $125 call for $7.90 per share and bought a January 18 $130 call for $5.25, you’d collect $2.65 per share in account credits. Since each option is worth 100 shares of FB, that’s a net credit in your account of $265.

That’s the max profit on this specific trade. You would keep this if shares fall below $125 during this trade. Right now, they are trading at $127.25, which is down by $6.12 on the day. A fall through $125 is quite possible.

The risk you’d run with this trade is found by taking the difference in strike prices ($130 – $125 = $5) and subtracting the credit received to open it ($5 – $2.65 = $2.35). Finally, multiply that by the 100 shares and you get a risk of $235 for this whole trade.

That works out to a return, which is received right at the beginning, of 113% of the amount of total risk in this trade. Meaning, the payout for this trade working out is higher than the amount of money you’d have at risk.

For it to succeed, Facebook would have to simply fall by 1.8% and remain weak until January 18 (expiration date). Considering the company doesn’t have an earnings announcement until after that date, there’s very little news that might change this whole situation around. Facebook finds itself unpopular right now. And that shouldn’t change.

— The Option Specialist

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About the Author: The Option Specialist