Trades

Facebook’s Rally Looks Decidedly Top Heavy

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Facebook (FB) might be the most controversial company in the market. It has 2.4 billion monthly active users… but almost zero active supporters. It is the Comcast of social media. People seem to use it because they feel they have to in order to stay connected. But they don’t really enjoy it.

Of course, since its inception in that famous Harvard dorm room, it has changed into something beyond anyone’s imaginings. It is now far more of a data company than a community of friends and acquaintances.

Going forward, the company plans even more change, including its own cryptocurrency. It now appears open to working with governments, instead of against them, on a framework on how to profit from its mounds of data.

But none of that offers much hope to today’s investors.

First of all, its cryptocurrency idea, named Libra, is unlikely to gain any support from the governments around the world. France just announced it is going to block it. The Swiss say they are concerned about it. And politicians from both aisle in the U.S. (yes, you read that right… both aisles) have serious issues with it.

The company is under attack now more than ever on its secretive data usages and collection. The Cambridge Analytica scandal of last year hasn’t entirely faded either. With ongoing investigations into how and to whom Facebook sells ad space and our data, especially heading into a Presidential election year, don’t expect much resolution there either.

Yet, despite all of that, the company’s share price has jumped 44% this year, more than twice the S&P 500. It is now the fifth largest company in the world, worth more than the likes of JPMorgan, Walmart and Exxon Mobil.

How can anyone reconcile these things for a company as hated as Facebook to do so well?

Well, we’ve already hit on it. 2.4 billion active users is about one-third of the entire earth’s population. No company has touched so many lives all at once ever. And it’s still growing. That 2.4 figure is up 8% year over year. Revenue from advertising, during its most recent quarter, jumped 28%.

Now, it’s clear that no matter what happens with Libra, its data collection scandals or the regulation of its advertising platform, Facebook isn’t going anywhere. But there are good reasons that a 44% year-to-date stock rally might be pushing things a bit too far.

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Consider this: Mark Zuckerberg has sold more than 2.7 million shares over the last month. This is nothing new. He’s reduced his stake before. But this represents nearly one-quarter of his holdings.

That’s not an insignificant amount of money. Insider trading can be one of the clearest indicators of a stock’s short-term outlook.

But even if this means nothing, and was an always-expected, completely-reasonable reduction in ownership, Facebook’s battles aren’t over.

The number of court cases it is entangled in is rising… not falling. With frontrunners on the Democratic side of the 2020 Presidential race in the U.S. (and the President, himself) calling for the company’s metaphoric head, negative stories won’t stop either.

Next year, as we near primary dates, those politicians will still likely spend on Facebook ads. But for right now, it’s all negative for the company.

Its year-to-date rally was too hot. And that gives us a chance to profit from its inevitable cooldown.

A Strategy For Short Term Bears

While you could go out and short Facebook, that strategy is extremely costly and might end up taking far too long even if you’re right. Instead, you could turn to a favorite strategy of ours, a bear put spread.

What this involves is going long one put option with a strike price close to the current price of the underlying stock… in this case Facebook. And then, shorting a second put with a lower strike price. So, you buy-to-open one put and sell-to-open a second one.

While this might not seem to make much sense right away, the way these two legs play off one another does. The income received from the short put helps offset much of the cost of the long one. That reduces the overall amount at risk in the trade.

You can still profit off the stock’s fall from the long put’s matching price increase. The short put does cap that total amount you can make off this trade. But that return-for-risk exchange is worth it.

You can see how this kind of trade plays out here:

bearputspread

Source: The Options Industry Council

Let’s look at a specific example of Facebook to see the finer points of this trade off…

A Specific Trade For FB

Right now, a trader looking to enter a bear put spread trade on FB shares could buy a November 15 $190 put for $9.90 per share and sell a November 15 $180 put for $5.73 for a total cost of $4.17.

Since each option is worth 100 shares of FB, that’s a total entry cost of $417. Compare that to the $990 it would cost to simply by the one put without using this strategy.

Now, that $417 is the total amount at risk from today until either November 15th or the trader closes out the trade. The profit potential however is even greater.

To find that, take the difference in strike price ($190 – $180 = $10), and subtract the cost ($10 – $4.17 = $5.83). On 100 shares, that’s a maximum profit potential of $583.

In other words, if shares come down from their ridiculously overheated year-to-date rally, this trader would be sitting on a 140% return on the amount he put at risk.

With so much facing Facebook – courts and legal fees, government denials for its Libra cryptocurrency and regulation and penalties on its data collection and usage – a $180 price point is not such a long shot.

In fact, with how fast the company has shot up over the last few months despite all of this, it is what any reasonable trader would expect over the next few. And this trade is the best way to play it.

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