Facebook has been on a tear in the past week, eclipsing the $40 level in one fell swoop on Friday, and continuing higher again today. We want to discuss the calendar (now diagonal) trade in Facebook that we currently have outstanding:
We ended up rolling the trade into the long Oct 38 / short Aug30th 40 Call diagonal. We had a lengthy debate before settling on this trade, with the following considerations in mind:
- Total Premium at risk – Since we were buying back the weekly Aug23rd 38 call for $2.50 to close, we did increase the risk in the trade by only selling an option at $1.05 for the next week. Granted, the Oct 38 call that we’re long was more valuable on Friday as well, but the main risk that we ran by selling less premium than we bought was a sharp fall in the stock over the next week, quickly hurting the value in our Oct 38 long call position. In that sense, our adjustment made us a bit longer delta than before.
- Decay per week – We ended up choosing the option with the most potential decay over the next week. We could have went farther out and collected more total premium, but we would have had to sit longer on the position for it to decay and we’d be short deltas for a longer period of time.
- Should we take position off entirely – We could have also just taken the trade off and moved on. However, we are still of the belief that front term options in FB are routinely overpriced relative to farther-dated options, so we want to stick with our current strategy of selling shorter-dated options against our October calls that capture a crucial earnings event.
For consideration 1), we took the risk of a sharp fall in FB this week because the $38.50-$39.50 area should likely serve as near-term support after Friday’s break higher. For consideration 2), that idea of short-term support holding also played a role, as did our view that the main risk to our trade is to the upside rather than the downside (in this case, we are only risking an incremental $0.35 vs. intrinsic value). For consideration 3), we still like playing the term structure over time.
Our hopes for the structure we settled on is for the stock to pull back towards or beneath 40 this week. At which time we’d collect most or all of the weekly 40’s we’re short. If the stock continues higher we’ll be forced into a decision in the structure as we’d be getting shorter, delta wise, than we’d prefer.
We’ll update on the site as we approach Friday.