Facebook: Option plays for Bulls and Bears
By: John Critchley
The Facebook (NASDAQ:FB) IPO has been a disaster and there is much blame to go around. Facebook shares are currently trading at $27.05, more than 40% below the intra-day high hit during the IPO debut. The most hyped IPO in history actually turned out to be one of the worst for the investors. The main culprits have been Morgan Stanley (NYSE:MS), NASDAQ (NASDAQ:NDAQ) and overzealous retail investors.
1) Morgan Stanley : The lead underwriters must bear some culpability for the IPO mispricing. Less than a week before the IPO, the size and price of the IPO increased. Incredibly, Facebook's revenue forecasts were lowered during the road-show and Morgan appears to have failed to properly disclose these negative revisions. Reports are circulating that only large clients received this material information.
2) NASDAQ : The technical glitches on the first day of trading were really inexcusable. There was the delay in start of trading and a more egregious delay in customer confirmations. Surely, some of the highly paid executives must have had some inclination of the enormous demand for Facebook shares. Everyone else knew. Why weren't better safeguards put in place?
3) Investors: Unfortunately, Facebook retail investors have garnered little sympathy in many quarters. Hype is not a reason to own a stock and many retail traders were sucked into the pre- IPO frenzy without doing their due diligence. Visions of Google (NASDAQ:GOOG) and its post IPO stratospheric rise must have been dancing in their heads.
Emerging from all this carnage are two camps on the ability of Facebook to effectively monetize their huge customer base. We present two option plays, one bullish and one bearish. Which camp are you in? Pick your poison
A Bearish Options Play
In a comparison to the AOL/Time Warner merger that marked the beginning of the end dot com era, many believe the hysteria and wildly overvalued Facebook IPO will be looked back upon as the bubble bursting event for social media stocks.
Are you in the bearish camp towards Facebook? If so, consider long bear puts spreads instead of straight put buys. Why? The out-of- the money puts are trading at a significant implied volatility premium to the at-the-money-puts. Let's use this to our advantage.
Let's look at a bearish options play:
The implied volatility in the June regular options appears to be quite reasonable at the 63-65% level considering the dramatic selloff in the underlying. The range in the underlying in less than two weeks of trading is $45.00-$27.86, an astonishing 40%.
To find a decent implied volatility option play, let's go out to the June '16 2012 options, which present some quite compelling short term option value.
Trade idea -
The play: To take advantage of elevated downside implied volatility skew and to benefit from any continuing downward pressure in Facebook over the next month.
a) Buy June '16 2012 27-24 put spread for $ .95. Receiving about 8.6% in Implied Volatility skew (buying 61.6 IV vs. selling 70.2 IV)
To finance this spread:
Let's sell the June'16 2012 30 calls @ .40 This is approximately a 58.20% Implied Volatility.
Net debit: $.55
Risk: You will be Short the stock over $30, a 9.2 % upward move in Facebook over the next month.
A Bullish Options Play
Are you a 'true believer' that the social media giant can effectively monetize its massive user base and effectively capitalize on the increasing mobile use of social media? Do you believe that the selling in the last few weeks was a complete overreaction and unwarranted capitulation? If yes, let's look at a bullish options play:
Trade idea -
The play: To take advantage of normal upside implied volatility skew and to benefit from any short-term bounce in Facebook.
Let's do a June risk reversal for a small debit to take advantage of normal downside Implied Volatility skew.
a) Buy the June '16 2012 29 calls for $ .70 paying about 58.8% Implied Volatility.
To finance this call purchase:
b) Sell the June '16 2012 24 puts @ .40, this is approximately a 73.3% Implied Volatility.
Net debit: $.30
This trade has three positive aspects worth mentioning:
1) If your bullish thesis turns out to be wrong in the short term, you will be put the stock at $24. Because of the demand for put options and the even more elevated price of the out-of-the-money puts, this is may be an attractive way to get exposure to the stock at a much lower cost basis.
2) Because of the demand for put options and their elevated price in comparison to the out-of-the-money calls, you are getting upside exposure for a discount.
3) Your are taking full advantage of a very robust implied volatility skew ( 14.5% skew)
Risk: You will be Long the stock under $24. Only an 11.1 % downward move in Facebook over the next few weeks.
Notes: Prices quoted where the prices at time of submission and do not reflect current market prices. You are solely responsible for your own trading and investments decisions and the ideas presented in this article are trade analysis, not recommendations.
We are not liable for any trading decisions made by any reader. NO advice is given or implied. The information offered in this article is for demonstration purposes ONLY and should not to be either construed as an offer or considered to be a recommendation to buy or sell any options.
Your use of this information is entirely at your own risk. It is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. You must assess the risk of any trade with a professional broker, or financial planner, and make your own independent decisions regarding any trades mentioned herein. This is not a solicitation to buy or sell any options, or to purchase or sell any credit spreads. Trading options only carries a high degree of risk, is not suitable for all traders/investors, and you may lose all of your premium money invested in the options. If you have never traded options before, we strongly recommend that you read a little background information made available by the government. Only you can determine what level of risk is appropriate for you. Also, prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options.
Past performances DO NOT guarantee future results. Please consult with your own independent tax, business and financial advisors with respect to any trade. We will NOT be responsible for the consequences of anyone acting on this purely demonstration material.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.