Name That Trade(s) – For $FB Holders

by Dan April 22, 2015 11:33 am • Commentary

Event: Facebook (FB) reports their Q1 results after the close, the options market is implying a one day move of a about 5.5%. With the stock just below $84, the April 24th weekly 84 straddle is offered at $4.75, if you bought that you would need a move above $88.75 or below $79.25 to make money, or about 5.5% in either direction.

Last quarter just prior to Q4 results FB was about $76.50, the implied move was almost 7%, and the stock closed higher by a little more than 2% after trading lower in early trading by almost 3%.

Sentiment: Wall Street analysts remain enamored with FB as a stock, with 46 buys, 7 Holds and only 1 sell.

Options Open Interest: over the last month calls volume has on average been nearly 2x that of puts, and total open interest of 1.1 million calls vs 725,000 puts reflects the recent build up in call open interest.  Nine of the top 10 strikes of open interest are calls, with the single largest strike 76,000 of the June 80 calls, with the second largest strike 61,000 of the June 80 puts.

Vol Snapshot:  30 day at the money implied vol (blue line below) is at lower levels than where it has been prior to the last few reports, one reason for this though is the relatively low levels of realized volatility (how much the stock has been moving) as it’s nearing 52 week and all time lows:

FB 1yr chart of 30 day realized vol (white) vs 30 day implied vol (blue) from Bloomberg
FB 1yr chart of 30 day realized vol (white) vs 30 day implied vol (blue) from Bloomberg

Price Action / Technicals:  The stock’s ytd gains of about 7.5% is besting the Nasdaq Comp by a couple percent, and more than 3x that of the S&P 500’s performance.

The one year chart has been a work of art, with most of the stock’s 50% gains from its 52 week lows coming in Q3, which was then followed by a very long base between $75 and $82 until the recent breakout:

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

Expectations:  As for the quarter, analysts expect 18% year over year earnings growth, and 43% sales growth

Top ranked internet analyst Mark Mahaney fromo RBC identified the following items to focus on in a note to clients:

1. User growth and engagement – FB has continued to grow users at a robust pace off a very large base (14% Y/Y & 1.39B users in Q4:14). At the same time, engagement (DAU/MAU) remains near all time highs. In Q1 we are estimating Y/Y MAU growth of 13% to 1.44B, with a Q/Q rise in the DAU/MAU ratio to 64%.

2. Ad Rev growth – FB saw ad revenue growth of 58% (ex-FX) in Q4:14. In Q1, FB will face its toughest Y/Y Advertising revenue comp, given that its Q1:14 Ad Revenue grew 83% Y/Y (ex-FX). We are modeling 48% Y/Y (ex-FX) growth in Q1:15.

3. Margins – FB produced an impressive 58% non-GAAP Op margin in Q4 despite entering an investment cycle. For Q1 we are looking for 50% Non-GAAP Op margin, down 690bps Y/Y as FB continues to step up its investments in R&D and Sales & Marketing. We note management stated opex will grow 50-65% Y/Y in 2015 on the Q4 call (down from the previous ’15 guide of 50-70%)

My View: I would say going forward that the law of large numbers is very likely to kick in sooner than later as sales growth is expected to decelerate from 58% in 2014 to 37% in 2015. While 37% on last year’s $12.5 billion is nothing short of impressive, the stock’s valuation adequately reflects this performance trading at 17.5x trailing 12 month SALES, about 14x expected 2015 sales.  With a $235 billion market cap, $100 billion less than GOOGL which had more than 4x FB’s 2014 sales, I suspect there is little room for error here.

Following Q4 results the stock was down for a few hours as investors foccussed on the deceleration in user growth, but that sentiment was quickly overtaken about FB’s growing opportunity in video viewing, hitting 3 billion per day an emerging challenge to YouTube’s dominance.

Sentiment seems in line with the company’s business momentum though, as it appears that mobile initiatives could start to add to the bottom line after more than a year of integration of WhatsApp, realignment of mobile aps, Instagram user monetization and of course slapping ads on those billions of video views.  Make no mistake, the stock is priced for perfection and I think the fact that the entire investment community seems so comfortable assigning a $235 billion market value (one third of Apple’s, who has more than 10x their trailing sales, but half their margins… kind of apples to oranges, but you get the point) seems a bit crazy to me.  If FB posts a beat and raise and user growth remains in low teens then the stock is off to the races, a miss and a guide down and further deceleration in user growth and the stock is back at $75 in a quick.

Hedge for Existing Longs:

Buy the FB ($83.90) May 90 – 80/75 put spread collar for .15

(versus 100 shares of FB stock)

– Sell 1 May 90 call at .75

– Buy 1 May 80 put for 1.40

– Sell 1 May 75 put at .50

Breakevens on May expiration – Loss of .15 plus gains or losses in the stock between 80 and 90. Called away in the stock above 90 for a net sale price on shares of 89.85. Protection in the the stock 1-1 below 80 (less .15) down to 75. Losses in the stock below 75.

Rationale – This protects against a techincal failure in the stock down to its 200 day moving average which should act as support on a move lower. You are called away in your shares at 90 on a breakout but that is at an additional 7+% gain in your stock.


Leverage for existing longs:

Buy the FB ($83.90) April24th weekly 87.50/90 1×2 call spread for .25

(versus 100 shares of FB stock)

– Buy 1 April 24th 87.50 call for .75

– Sell 2 April 90 calls at .25 (.50 total)

Breakevens this Friday – loss of .25 below 87.50 with no protection provided if the stock goes down. Added gains in the stock of up to 2.25 above 87.75 with max gain of 2.25 (alongside gains in the stock) at $90. Called away in the stock above 90 but at an effective sale price of 92.25.

Rationale – This is a really inexpensive way to add leverage for a breakout with very low risk of messing up said breakout as the effective sale price is nearly 10% higher.