Strategic Mindset - At Top Gun Options we remain market neutral with a bearish bias. China's slowdown, continuing Euro Zone troubles, our own fiscal cliff, and weak corporate earnings give us sufficient ammo to support this mindset. As the world continues to face considerable financial headwinds we have identified one stock in particular that will continue to struggle in these uncertain economic times.
Commit Criteria - We believe that Facebook (NASDAQ:FB) is significantly overpriced after a 15% pop the stock experienced after releasing earnings last week. At its current price FB trades north of 40 times 2012 projected earnings. If this doesn't sound like a lot, search giant Google (NASDAQ:GOOG) trades at 17 times 2012 earnings. Both of these stocks are struggling to monetize handheld advertising profits and FB has been extremely slow out of the gate to attack this issue compared to GOOG.
Tactic - November Bearish Double Vertical Spread:
Sell 30 Nov 12 18/20/23/25 Double Vertical Spread for credit of .10 ($300)
This tactic involves selling a Bear Call Spread (Nov 23/25 credit spread) and buying a Bear Put Spread (Nov 18/20 debit spread). We like this tactic at Top Gun Options because when done correctly an investor can potentially take in a credit by employing a Double Vertical Spread, essentially being paid for their strategic mindset on a stock.
Historical vol is below implied vol although not by much so this supports a tactic that involved buying and selling spreads simultaneously.
Tactical Employment -
- Sell 30 Nov 18 Puts
- Buy 30 Nov 20 Puts
- Sell 30 Nov 23 Calls
- Buy 30 Nov 25 Calls
- Credit .10 ($300)
- Max Potential Profit $6300
- Max Potential Loss $5700
- Breakeven $23.10, 68% probability using at-the-money volatility
Midcourse Guidance - I am taking in a credit in the Primary Model Portfolio and at a minimum want to retain the $300 credit. However if I see a significant pullback in the stock and the position reaches a profit of $3150 I will close half the position and let the remaining 15 contracts ride. This will depend on the velocity of the downside move however and I may elect to hold the position for max profit. Standby for SMS and email updates as conditions dictate.
Eject Criteria - I will eject from this trade in order to retain the $300 credit received and will set up this Exit Plan according on the TradeMonster paper trading platform.
Bottom Line - FB's current value is also well understated. Therefore we may look to employ this position out to December and/or January. The company sprinkles stock on employees like there's no end and if one takes this into account FB's 2013 PE rises to over 50. The stock is overvalued, has placed user experience below profit, cannot monetize its growing base of mobile users and is led by a CEO that wears a hoodie.