Tech has had a volatile week. Apple (AAPL) missed earnings consensus estimates and fell 5.5% in the after hours. Google (GOOG) on the other hand hit analyst targets and climbed 3%. Facebook (FB) is set to release its first earnings report as a public company on Thursday after the market close. However, after the two tech bellwethers Apple and Google sent the market mixed messages, I'm puzzled like many on how to exactly trade Facebook stock.
In these times of uncertainty it is a good idea to capitalize on volatility. With option trading a strangle, different than a straddle, is an investment strategy involving the purchase or sale of a particular option derivative that allows the holder to profit based on how much the price of the underlying security moves, with relatively minimal exposure to the direction of price movement. The strategy involves buying an out-of-the-money call and an out-of-the-money put option.
To take advantage of tech volatility, I will explain how to trade Facebook. Below is a calendar of FB options expiring August 17.
To employ the strangle option strategy a trader enters into two option positions, one call and one put. The trader wants to purchase 50 contracts (1 contract = 100 shares) for a call position and 50 contracts for a put position. Say the call is for a $32 strike price and costs $3,500 ($.70 per option contract x 100 shares x 50 contracts) and the put is for a $25.00 strike price and costs $3,750 ($.75 per option x 100 shares x 50 contracts). If the price of the stock underlying stays between $32 and $25 over the life of the option the loss to the trader will be $7,250 (total cost of the two option contracts). The trader will make money if the price of the underlying starts to move outside of the range. Say that the price of the stock ends up at $35. The put option will expire worthless and the loss will be $3,750 to the trader. The call option however has gained considerable value. The value of 50 contracts of an in-the-money expired call option would be worth $15,000 ($3.00 per option x 100 shares x 50 contracts). So the total gain the trader has made, minus $3,750 loss and $3,500 original investment, is $7,750.
Lets say for instance the Facebook trade turns sour and the price of the stock ends up $22. The call option will expire worthless and the loss will be $3,500 to the trader. The put option however has gained considerably. The value of 50 in-the-money expired call options would be worth $15,000 ($3.00 per option x 100 shares x 50 contracts). So the total gain the trader has made, minus $3,500 and $3,750 original investment, is also $7,750.
*A trader can sell the underlying, in this case FB, at anytime. He or she does not have to hold an option through the expiration date.