Facebook (NASDAQ:FB) shares won't be available to the public for a few months but that hasn't stopped it from making an impact on the market already. Since Facebook's S-1 filing this past Wednesday, last year's internet IPO darlings have been on an absolute tear. Shares of Linked In (NYSE:LNKD) and Groupon (NASDAQ:GRPN) have soared more than 10% and 20% respectively. The biggest benefactor of the soon to be biggest IPO in history was Zynga (NASDAQ:ZNGA). With news surfacing that Zynga accounted for 12% of Facebook's revenue, Zynga shares have had a parabolic move up as much as 44% just this week as of the high on Friday on 8x average volume this year.
Options activity has gone haywire as well. Call option volume started to register a significant move on Monday, January 24th. Abnormal activity was detected in the Feb $10 calls with a 1,744 contract block sold for .40c. That same call less than two weeks later is now worth $3.50 (incidentally, news of Facebook's IPO was released a few days after that Monday's abnormal activity on Friday January 28th - go figure). January 24th was also the first day Zynga traded more than 10 million shares for the year. Since then, it has traded north of that number 50% of the time, with volume soaring north of 55 million shares the past two days! Volatility has increased along with it. On Friday for example, there was a $1.69 spread, or 13%, between the stock's low ($12.75) and high ($14.44). Even greater was the previous day, which had a $2.07 spread, or 19%, between the stock's low ($10.84) and high ($12.91).
This volatility may be too much for the normal buy and hold investor, but like the nomadic surfer searching the globe for the next perfect wave, options traders will be drawn to ZNGA for the next week and a half. That's because ZNGA is set to report earnings after hours on February 13, 2012. Facebook's IPO revealed that in 2011, Zynga accounted for 445 million (12%) of Facebook's overall revenues. That is up from $177 million in 2010, an amazing growth of 251%. Bullish traders betting on a similar increase in growth are positioning themselves in the options market. Those skeptical of these numbers and the sustainability of such growth are actively purchasing puts. The options activity is greatest in the February expiration since it captures the earnings call. On Friday between the $9 and $18 strikes, 44,472 call options were bought and sold, as well as 31,291 put options. The Feb 14 call saw the greatest call volume with 9,493 calls traded, while the Feb $12 put saw the greatest put volume with 13,811 puts traded. Open interest was greatest for both calls and puts at the $10 strike with 23546 and 9284 respectively.
If Friday is any indicator, there is no telling which direction Zynga's stock will go in the seven trading days left until earnings release. Friday saw the stock price catapult 13% from the morning to just before noon. Soon thereafter, the stock dropped more than 7% to end the day. While the direction is uncertain for Zynga, volatility is most likely to continue in the next seven days. To best take advantage of this volatility, executing a strangle by purchasing an out of the money call and put (equally out of the money both ways) and closing it prior to earnings should be lucrative. The profit is unlimited while the losses are capped to the premium paid. This is a simple, straight-forward strategy that can increase in value irrespective of direction by virtue of the implied volatility. I have provided an example below of this strategy in Zynga that has already worked to perfection.
Thursday, February 2/2/12:
Zynga - $12.38
- Buy Feb 14 Call - .50c (1.62 Out of the Money)
- Buy Feb 11 Put - .55c (1.38 Out of the Money)
- Cost - $1.05
Friday, February 2/3/12:
Zynga - $13.39
- Feb 14 Call - $1.20
- Feb 11 Put - .45c
- Value = $1.65
One day return on investment: .60c - 57%
As you see from the illustration above, a strangle that was executed on Thursday (a $1.50 roughly OTM each way) netted a 57% profit in one day. In fact, during the day, the value was as high as $2.10 (the call was 1.80 and the put was .30c). Had it been closed at that time, the return would have been a double up! A more conservative 13call/12put would have returned a 27% profit. The same type of trade worked from Wednesday to Thursday as well. As you can see, the put did not lose much value relatively speaking and that is attributable to implied volatility. Essentially, that is what makes the trade work (prior to earnings).
Similar gains are to be had in the near future should Implied volatility remain high as it did on Thursday and Friday. Unless you have the gift of foresight, there is no reason to take a bullish or bearish bet in this name. That is tantamount to betting black or red on a roulette table (no offense to you roulette players). In situations like these, where no conviction exists as to direction either way, but volatility is likely, a strangle is ideal. Think of it as you being a boxing promoter who is promoting both fighters in the same ring. To you, it doesn't matter who wins, just as long as the fight happens and someone hits the mat - you get paid regardless. That is the idea of executing a strangle. Put yourself in a position to win no matter if the stock goes up OR down. As long as the moves are great enough (as we've seen in the high percentage moves in Zynga), you will turn a profit. The following proposed strangle is based on Friday's at the close numbers so it is important to adjust accordingly if numbers are different on Monday.
- Feb 15 call - .80c (mark is .75c)
- Feb 12 put - .80c
- Cost - $1.55
This strangle only costs $1.55-$1.60 to put on and should reap substantial gains should Zynga continue to trade like it did Thursday and Friday. A more conservative trade would be to bring the strikes in closer to say a Feb 14call/13 put. While that may work, its gains would not be as great as the 15c/12p strangle. Others may propose a reverse iron condor structure, but that option trade will limit upside gains. Yes, downside risk is also limited in those strategies, but in specific cases like Zynga where there are potentially gigantic returns to be had, the risk is worth the reward.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The strangle is neither a long nor short position.