Name That Trade – $FB: Poking Around

by Dan March 16, 2015 2:00 pm • Commentary

Shares of Facebook (FB) have been stuck between $74 and $82 for the better part of the last six months and importantly have not confirmed a new high in the S&P 500 since late last year:

FB 1yr chart from Bloomberg
FB 1yr chart from Bloomberg

This lack of movement is reflected in short dated options prices, as 30 day at the money implied vol (blue below) nears all time lows. But the problem with calling options prices cheap is that 30 day realized vol (white below) is at 21, meaning the stock is not moving and therefore owning options can be a painful endeavor:

FB 1yr 30 day at the money IV vs Realized Vol from Bloomberg
FB 1yr 30 day at the money IV vs Realized Vol from Bloomberg

So what t0 do? If you are long the stock, one might consider adding yield in what could continue to be a range bound stock prior to the company’s Q2 results expected in late April (it should fall in May expiration).  So just as we say sometimes it makes sense to buy expensive vol if one has a convicted directional view, it can go the other way too. Sometimes it makes sense to sell cheap vol as it has the potential to get cheaper, and definitely for those situations where people are looking to add yield to a long stock position.    

If I were long FB with no intention to sell, but think the stock could be stuck between 74 and 82 until an event that could make the stock breakout one way or the other, I would consider selling strangles against my long.

Hypothetical Overlay Trade:

FB Against 100 shares of long stock at $77.65, Sell to Open April 75/80 Strangle at 2.55

-Sell to open 1 April 75 put at 1.25

-Sell to open 1 April 80 call at 1.30

Break-Even on April Expiration:

Profits:  gains of the stock between 77.65 and 80, stock called away at 80, but have added 2.55 or 3.3% yield so effectively selling at $82.55 up 6.3%.  If the stock is above 80 one could merely buy to close the short call leg.

Losses: of the stock below current levels, but the 2.55 in premium received for the straddle sale creates a buffer to the downside. If the stock is below 75 on April expiration then you would be put 100 shares of stock at 75, but would effectively own the stock at $72.45, down 6.7%.

The best case scenario would be the stock closing at $79.99, registering the gain in the stock and collecting the 2.55 in premium for the strangle sale.