After Facebook’s (FB) fairly rocky start in 2012 as a publicly traded equity, the shares have garnered “last man standing” status in 2014 among most internet social media and web services companies. FB shares are up 45% in 2014, trading near all time highs, while shares of social media peers Twitter (TWTR) and LinkedIn (LNKD) are down 22% and 7% respectively on the year. Moving down the ladder to web services stocks like Pandora (P) and Yelp (YELP) it becomes apparent that the very brief 2013/2014 internet bubble, (call it 2.1) has essentially burst for most names, with these two down more than 40% from their March highs and both down on the year.
But it hasn’t just been new-fangled web stocks, losses on the year for large cap internet stocks:
Amazon.com (AMZN): down 28%
eBay (EBAY): down 7%
Google (GOOGL): down 2.6%
Priceline.com (PCLN): down 3%
In the large cap internet category, aside from FB, it’s just Alibaba (BABA), Netflix (NFLX) and Yahoo (YHOO) with gains in 2014, with NFLX up just 3% following last week’s one day earnings implosion to the tune of 20% and YHOO has also just eeked up some ytd gains after rallying 10% since earnings Wednesday with ytd gains now of 7%.
I guess the point here is simple, sentiment has shifted away from the more speculative smaller stocks with less proven business models, but also from some prior leaders like AMZN and GOOGL in favor of the new kids on the block like BABA and FB who have captured investor fascination.
FB Q3 EARNINGS
FB is scheduled to report their Q3 results after the close on Tuesday, the options market is implying a one day move in either direction for Wednesday of about 6.5%, which is rich to its 4 qtr average of 5.5% but shy of its lifetime average of about 10%.
As one would expect with FB’s 45% year to date gains (equaling about $80 billion in market cap) Wall Street analyst sentiment seems to mirror that of investors with 44 Buys, 9 Holds and only 1 Sell on the stock with an average 12 month price target of about $88 or 10% higher than current levels.
From a technical standpoint, the 1yr chart is a work of art. It has had a fairly orderly ascent followed by periods of consolidation and then new highs. The stock’s recent volatility, from $79 to $70 and back to $80 is slightly greater than the price action of the S&P 500, whcih makes sense given the nature of the beast but to be fair the price action was pretty orderly for a $200 billion market cap company that trades at 20x trailing sales.
On a near term basis the stock could be mildly overbought heading into next week’s earnings. $70 should serve as important support, the level it gapped above following Q2 earnings in July and last week’s low:
From an Implied Vol basis options prices look fair to almost cheap when you consider that in the days following next week’s earnings, shares awarded to the owners of FB’s recently closed WhatsApp deal come unlocked and can be sold in the open market, per Bloomberg.com:
As many as 178 million shares, or 8.8 percent of Facebook’s outstanding stock, may enter the market as a lockup on stock sold during the acquisition expires, according to Goldman Sachs Group Inc. analyst Heather Bellini. The shares could become available for trading in the two or three days after Facebook reports earnings on Oct. 28, Bellini said.
Looking at the Oct 31st weekly 80 straddle (the put premium plus the call premium) the weekly move is priced at about 7.5%, which is not much greater than the one day post earnings implied move of about 6.5%.
The one year chart of FB’s 30 day at the money IV below shows the recent decline in options prices since last week’s broad market lows, but also the fact that options prices are below the levels of each of the last 3 earnings reports over the course of 2014:
LIKE PROTECTION?
So here is the thing, if you own Facebook and have fabulous gains, this upcoming quarterly report and lockup expiration could offer some unwanted volatility, not even mentioning the potential for a return to the broad market volatility of the last few months. So for holders who want to protect gains you have some choices:
1. You could look at stock replacement strategies where you would sell your long stock and either look to define your bullish view through long calls or spreads, or short puts or spreads that give you long exposure at a pre-set price to the downside, or Risk Reversals where you sell out of the money puts to buy upside calls and define a wide band where to get long on both up and downside
OR
2. Protection in the form of long puts or put spreads to keep you long your stock but defining a level where you would set a stop to the downside. Generally we are not huge fans of protective puts because really what you are long is an expensive call.
BUT here is a trade structure that should interest those who are long and find bits and pieces of the above interesting.
Hypothetical Hedge Overlay to 100 shares of FB long at $80:
Trade: Buy the FB ($80) Dec 70/90 Collar for even money
-Sell to Open 1 Dec 90 call at 1.20
-Buy to Open 1 Dec 70 put for 1.20
Break-Even on Dec Expiration:
Profits: Gains of the stock btwn 80 and 90, or 12.5%, long stock called away at $90
Losses: between 80 and 70 up to 10 in losses of the stock, but protection below 70, last week’s low, down 12.5%
Rationale: We are believers in tactically hedging your best and most convicted ideas from time to time. FB’s performance in 2014 is impressive given the markets general disdain for high valuation stocks for the better part of the last ten months. Collars can be used to avoid blow ups while allowing for upside participation and can always be taken off higher for slight losses. They offer investors a good bit of optionality into potentially volatile events or periods in the market.