**Facebook Bucks Two Bearish Indicators**

In an article earlier this month (Facebook: Proceed With Caution), we noted two reasons for Facebook (NASDAQ:FB) longs to be cautious, the potential "double top" formation cited by Karl Eggerrs below:

And the spike in dark pool short interest flagged by SqueezeMetrics in the next chart.

On the bullish side then were Portfolio Armor's website, which estimated a potential return of 8.3% for Facebook over the next five months, and Wall Street sell-side analysts, whose median price target for the stock implied a similar potential return of about 10% over that time frame. Those sell-side analysts rushed to raise their price targets after Facebook's impressive Q1 numbers.

**What Happens To Hedges When A Stock Goes Up**

In our previous article (Hedging Apple), we looked at how hedges on Apple (NASDAQ:AAPL) reacted as that stock sank after earnings. In this one, we'll look at how our Facebook hedges reacted as FB's shares rose. As we noted in our initial article on hedging Apple, a sharp move up in a stock can make it costly to exit a collared position early:

As with the optimal puts above, this (optimal collar) hedge may provide more protection than promised if the underlying security plummets in the near future, due to the put leg's combination of intrinsic value and time value (for an example of this, see the section titled "More Protection Than Promised" in this article). However, if the underlying security spikes in the near future, the combined time value and intrinsic value of the call leg can have the opposite effect, making it costly to exit the position early.

We'll see an example of that below with a Facebook collar. First, though, we'll look at the Facebook put hedge.

**Status Of The April 13th Optimal Put Hedge**

These were the optimal puts to hedge against a greater-than-16% drop in 300 FB shares over the next five months, as of April 13th's close (the screen capture below is from the Portfolio Armor iOS app).

Here's an updated quote on that put, as of Thursday's close.

**How That Hedge Reacted To Facebook's Rise**

FB closed at $110.51 on Wednesday, April 13th. A shareholder who owned 300 shares of it and hedged with the puts above then had $33,153 in FB stock plus $1,350 in puts. So, his combined hedged position value on April 13th was $33,153 + $1,350 = $34,503.

FB closed at $116.73 on Thursday, April 28th, up 5.6% from its closing price on April 13th. The investor's shares were worth $35,019 as of 4/28, and his put options were worth $663. So, $35,019 + $663 = $35,682. $35,682 represents a 3.4% gain over $34,503.

**Drag On Return**

So, although FB had climbed 5.6% at the time of the calculations above, and the investor was up only 3.4% on his combined hedge + underlying stock position by this point.

**Best- And Worst-Case Scenarios**

The best-case scenario here is FB keeps going up, and the investor's return by mid-September will be the return of Facebook over that time frame, minus what he paid for the put options (~4%). The worst-case scenario is Facebook plummets from here, and the investor is down no more than 16% from the April 13th closing price by mid-September. That 16% decline would include the cost of the hedge.

**Status Of The April 13th Optimal Collar Hedge**

As of April 13th's close, this was the optimal collar to hedge 300 shares of FB against a greater-than-16% drop by mid-September while not capping an investor's upside at less than 13% by the end of that time period.

As you can see above, the cost of this hedge was negative, meaning the investor would have collected about $150 more from selling the call leg than he paid for the put leg.

Here's an updated quote on the put leg as of Thursday's close:

And here is an updated quote on the call leg:

**How That Hedge Reacted To Facebook's Rise**

FB closed at $110.51 on Wednesday, April 13th. A shareholder who owned 300 shares of it and hedged with the collar above then had $33,153 in FB stock plus $975 in puts, and if he wanted to buy-to-close his short call position, he would have needed to pay $1,125 to do that. So, his net hedged position value on April 13th was ($33,153 + $1,125) - $975 = $33,303.

FB closed at $116.73 on Thursday, April 28th, up 5.6% from its closing price on April 13th. The investor's shares were worth $35,019 as of 4/28, his put options were worth $414, and if he wanted to close out the short call leg of his collar, it would have cost him $1,452. So, ($35,019 + $414) - $1,452 = $33,981. $33,981 represents a 2.5% gain from $33,153.

**Cost Of Exiting Early**

So, although FB was up by 5.6% at the time of the calculations above, if the investor hedged with this collar wanted to exit his position on Thursday, his gain would have been limited to 2.5%.

**Best- And Worst-Case Scenarios**

The best-case scenario here is Facebook keeps going up, and is up 13% or more from the April 13th closing price by mid-September. In that case, the investor would be up 13% from the April 13th closing price, plus the ~$150 negative hedging cost. The worst-case scenario is Facebook plummets from here, and the investor is down no more than 16% from the April 13th closing price by mid-September, minus the ~$150 negative hedging cost.

**Disclosure:** I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.