Shares of Facebook (NASDAQ:FB) have fallen from the $38 IPO to just $17.73 as of this writing, a full 53% decline. Of course, even the most cursory glance at the company's financials would have told you that $38 was an absurdly high price for a company that can't seem to figure out how to monetize an enormous user base. The stock has now reached levels that may be attractive to some investors, but the downward trend raises fears of buying well before the bottom. The good news is that option premiums have become lucrative, and by selling put options you can lower your purchase price substantially and receive a premium for your troubles.
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An option has three components: A strike price, a premium, and an expiration date. By selling a put option, you are giving the buyer of that option the right to sell you the underlying stock at the strike price on or before the expiration date. The buyer pays you the premium in exchange for this right. You keep this premium no matter what happens, but are required to buy the stock if the option is exercised.
Here's a list of a some put options available to sell at a couple different strike prices.
|Expiration Date||Strike Price||Premium||Annualized Return|
|Oct 12 (44 days)||$13||$0.13||8.30%|
|Nov 12 (73 days)||$13||$0.35||13.46%|
|Dec 12 (108 days)||$13||$0.51||13.26%|
|Jan 13 (136 days)||$13||$0.70||14.45%|
|Jan 14 (500 days)||$13||$2.00||11.23%|
|Oct 12 (44 days)||$15||$0.40||22.12%|
|Nov 12 (73 days)||$15||$0.80||26.67%|
|Dec 12 (108 days)||$15||$1.05||23.66%|
|Jan 13 (136 days)||$15||$1.18||21.11%|
|Jan 14 (500 days)||$15||$2.90||14.11%|
When you sell a put option there are two possible outcomes.
- The market price never drops below the strike price. The option expires worthless and you are free to write another put. You are not required to buy any shares.
- The market price dips below the strike price and the option is exercised. You are forced to buy 100 shares of Facebook stock at the strike price, which will be higher than the current market price. The premium received effectively lowers your per-share cost.
A $15 strike price offers a 15.4% discount to the current market price, while a $13 strike price offers a full 26.6% discount. This means that the stock price would have to fall by these percentages in order for each respective option to be exercised. The $15 Nov 2012 put offers a premium of $80, giving you a 26.67% annualized return (5.33% over 73 days). If you require a lower price before committing to Facebook the $13 Jan 2013 put offers a premium of $70, giving you a 14.45% annualized return (5.38% over 136 days). Obviously, there is a tradeoff between the strike price and the premium, and if you're comfortable buying Facebook at $15 per share, the premiums offered are extremely lucrative.
Facebook stock is reaching a very interesting level, trading at less than half of the IPO price. Although future profitability remains fuzzy at best, the company certainly has a lot of potential. Selling put options allows you to lower your purchase price, while receiving a substantial premium - of 26.67% annualized in one case. Even at a much lower strike price of $13, the premiums received are nothing to sneeze at. If you're looking to buy into Facebook, consider selling puts as your entry strategy.