Buy All Your Friends With This Facebook Trade

Facebook is yet again in the investors’ doghouse this week as it continues to struggle with its public relations.

The company’s shares were downgraded by a number of analysts due to public appearance, headline risk and most importantly, executive departures. These downgrades and issues the company face will keep downward pressure on it at least until its next earnings call.

The social media giant has seen a number of its management leave the company over disagreements with Mark Zuckerberg. These departures seem to stem from former Chief Product Offer Chris Cox’s argument with Zuckerberg over the latter’s intention to make Facebook a “more private company.”

So far, 11 executives have followed Cox out the door, leaving many to worry about what kinds of changes Zuckerberg intends and why it is so controversial with his former management team.

That story, while a large one looming over the company for at least investors, isn’t the only problems it faces. The recent attack on a mosque in New Zealand was live streamed on Facebook, causing many to repudiate the company. It took nearly a half of an hour before the social media company took the stream down.

In yet another negative news story, President Trump is now going after the company for its strange ban on his social media chief Dan Scavino. It seems the company can get nothing right of late. And it has investors scared.

Shares are down more than $11 from last week’s highs. And even with a slight rebound today, this downward pressure is likely to continue.

Now, none of this is to suggest that Facebook is in real trouble in the long term. Zuckerberg might be intending some changes like how to integrate the company’s various platforms like WhatsApp and Instagram. But that doesn’t mean that is a bad thing. Many users might see that as a positive… and advertisers too, depending on how it’s done.

You have to also consider that with the 2020 presidential election already underway, political ads have started to tick up. While Trump has been publicly condemning Facebook of late, he’s already been pouring money into it for advertisements. And on the other side of the aisle, Democrats are setting records for fundraising left and right. That money will undoubtedly find its way in the social media leader’s pockets.

So, all is not lost. But there are two catalysts investors are likely to wait for before they begin buying back into Facebook shares.

First, everyone is waiting for more news from Zuckerberg on his intentions to change and make “a more private Facebook.” That won’t likely be cleared up until at least its next earnings call at the end of next month.

The other major reason to wait on buying Facebook… and one completely outside of the company’s control… is the potential Pinterest IPO, tentatively planned for June. The same investors that would be most interested to pick up additional shares of Facebook might be waiting to see how that launch goes first.

The two social media platforms are clearly of vastly different sizes and strategies. But the same investor dollars will be on the line for them.

So, with all of the negative press, anxious investors, analyst downgrades and down-the-road catalysts, Facebook will likely have a flat to down few weeks. Shares could easily fall back to where they were at the start of the year, in the $135 – $150 range. Right now, they are still trading at a $162-$163 price point.

That means there’s a real opportunity to play this short-term hiccup at the industry leader. And you don’t have to risk the long-term rebound that might very well happen if the company can power through this period.

Using an options strategy we frequently use around here, you could get in and out of a trade before either of those catalysts pop up on the calendar.

Let’s take a look at this strategy now…

A Strategy For Short Term Weakness

A bear put spread is a type of trade that involves two put options with different strike prices but the same expiration date.

The way it works is by buying a near-the-money put on a stock you believe will fall in price. Then, you sell a second put option with a lower strike price but the same expiration.

This results in a net debit, since the bought put will have a higher premium. But the income received from the second (sold) put vastly reduces the amount of money at risk for the duration of this trade.

The entry cost of this type of trade is the only amount at risk. A trader cannot lose more than that amount at any point in the trade.

The maximum profit of such a strategy is found by taking the difference in strike prices between the puts and subtracting the entry cost.

It becomes more profitable the farther shares fall in price until it maxes out below the sold put’s strike price.

You can see how that looks here:


Source: The Options Industry Council

Let’s look at a real example of this kind of strategy utilized on Facebook’s stock.

A Specific Bear Put Trade on Facebook

A trader looking to use this strategy to profit from Facebook’s down month could buy an April 18 $162.50 put for $4.80 per share and sell an April 18 $160 put for $3.71 per share for a net debit of $1.09 per share. Since each represents 100 shares, that’s $109 total at risk.

The trader cannot lose more than that $109 on this trade. That’s less than the cost of a single share of Facebook and significantly less than the cost of just buying a put outright.

To find the trader’s maximum profit potential, take the difference in strike prices ($162.50 – $160 = $2.50) and subtract the entry cost ($2.50 – $1.09 = $1.41). On 100 shares, that’s a potential return of $141… or 129% of the amount at risk.

That’s a large potential return for just a $2.50 per share fall in Facebook’s price. In fact, that only represents a total decline in share price of just 1.5%. With so much negativity surrounding the global social media giant right now, that’s a very likely outcome.

— The Option Specialist

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About the Author: The Option Specialist