Get Facebook Under $25, Or Get $3-Plus In Cash

Jul.12.12 | About: Facebook (FB)

Since I'm an avid follower of technology stocks and I write about them often on this site, you can imagine how many questions I've received regarding Facebook (NASDAQ:FB). Yes, Facebook has been trading for less than two months, but it already has garnered plenty of headlines and investor attention. Now, I've argued in the past that Facebook's current valuation is unreasonable, especially when compared to other names in the space.

But even though my personal opinion is that Facebook could go lower from here, I've gotten plenty of questions from investors who are interested in the other side of the trade. Not all of the investors want to be long, but they want to be involved in the name. They've asked me for a trade recommendation, and it doesn't only have to involve the stock.

I've covered this strategy before with several other names, so I'll demonstrate it with Facebook today. The trade involves selling puts below where the stock is currently. In this trade, you receive a premium for selling the puts. If the options are exercised, you are forced to buy the stock at that price, but since you pocketed the premium, you really get shares for a bit cheaper. If shares don't get exercised, you keep that entire premium. Now remember, you must be able to post margin for this trade (which can vary by broker) because if the options are exercised, you have to buy the shares. Your profits could also be cut, depending on the amount of commissions involved, but those also vary by the broker.

So today I will focus on the January 2013 puts. The following table shows the following put strikes as well as the associated premium for selling them. I've also included a column called "Entry" for what you would essentially pay for the stock, should the options be called (again, not including commissions). The final column, "Value", is how much you get, based on today's price. So if you got a 10 cent premium on a $1 stock, the "Value" would be 10%.

Strike Premium Entry Value
$20.00 $0.85 $19.15 2.74%
$21.00 $1.05 $19.95 3.39%
$22.00 $1.25 $20.75 4.04%
$23.00 $1.45 $21.55 4.68%
$24.00 $1.75 $22.25 5.65%
$25.00 $2.00 $23.00 6.46%
$26.00 $2.35 $23.65 7.59%
$27.00 $2.70 $24.30 8.72%
$28.00 $3.10 $24.90 10.01%
$29.00 $3.50 $25.50 11.30%
$30.00 $4.00 $26.00 12.92%
Click to enlarge

Based on the title of the article, you can guess which strike I'm focused on. That's right -- the $28 puts. If you sell them based on Wednesday's closing prices, you would receive $3.10. If Facebook doesn't drop too far below that level, and the options are not exercised, you pocket $3.10. By January, that's a 10% value based on today's price. 10% for 6 months. Now, if the options are exercised, you are forced to buy the shares at $28. But you keep the $3.10, so you are essentially paying $24.90 for them. Not too bad a deal right now.

Now, if you think there's a chance Facebook could decline a little more, you could do one of two things. First, you could sell a lower strike, say the $25 strike for $2. The other option is wait for the price to come down a little, and then sell a lower strike. For example, if Facebook dropped to $28 in the next month, you probably could sell that $25 strike for about $3.

I hope this trade works for investors that have been looking for a unique play on Facebook. It's not the most complicated one out there, but it does involve some level of risk. Obviously, you have to trade options and use margin, and those both carry a bit of risk. There are two possibilities on the recommended trade. Either you pocket $3.10, or you get to buy Facebook shares at $24.90.

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