Last night, on CNBC’s Fast Money we discussed the management shake-up at TWTR. I mentioned that the company’s expected $2.2 billion in sales in 2015 is a drop in the bucket for both Google’s (GOOG) expected $60 billion in sales and The Facebook’s (FB) expected $17 billion in sales this year, relegating TWTR to a sort of bit player in the online ad market, despite those sales growing north of 50% yoy. It is my view that TWTR is merely a pawn in what is an increasingly competitive online mobile ad chess game between Facebook and Google. Investors have priced FB for continued 30% plus sales growth for years, despite profitability being crimped by aggressive spending (trades 13.5x expected 2015 sales and 41x expected 2015 earnings), while investors are pricing in sales and earnings growth not too much above 10% for GOOGL which is showing a marked deceleration (trades 6x expected 2015 sales and 19x expected 2015 earnings). Which all makes sense given expected growth.
Make no mistake, the first blip we see in sales growth and FB will be re-rated, and quickly. To put the market values in context, FB has a $230 billion market cap on $12.5 billion in trailing 12 month sales, while GOOGL has a $367 billion market cap on $52.5 billion in trailing 12 month sales. When the day of reckoning comes for FB, it won’t be pretty and it will likely be a combination of greater than expected spending coupled with slower than expected user growth and sales.
FB has proven me wrong on many occasions in the last few years. Their ability to grow ad dollars, expand in mobile messaging, photo sharing and now video, has been astounding. But just as we discussed this morning with TWTR, separating the stock, the company and the products can be the difference in making and losing money investing.
The company is clearly on a roll and for now, with sales growing north of 30% a year, investors don’t seem to be bothered with valuation. The next identifiable catalyst will be Q2 earnings expected the last week of July, and the stock’s current range-bound action and resulting low implied volatility could make for good timing for existing shareholders to consider defined risk ways to play for a breakout to new all time highs while protecting against disaster. I suspect every quarter from here on out for FB poses significant gap risk for when the company finally disappoints. While that would be a very silly reason to sell a stock that you have gains in, and equally silly to commit capital to put protection every-time you get worried, there are options strategies against long stock positions that offer the ability to participate in upside while protecting against disaster.
The chart since the start of 2014 shows the fairly orderly uptrend, but has spent the better part of 2015 between $75 and $85:
A gap on fundamental news below the uptrend would quickly put $75 back in play.
Despite relatively low levels of options prices (in implied volatility terms), at the money options, isolating the earnings event in the last week of July are not exactly dollar cheap. For instance, with the stock at $81.70, the July 24th weekly 81.50 strike calls are $3.10, or about 3.8% of the underlying stock price, offering a break-even at $84.75.
So how do you define a range of potential profitability while also providing downside protection into a potentially volatile event? A collar against your long stock.
Hypothetical Trade – Against 100 shares of FB at $81.70: Buy Aug 75 / 90 Collar for 30 cents
-Sell 1 Aug 90 call at $1.10
-Buy 1 Aug 75 put for 1.40
Break-Even on Aug Expiration:
Gains: of stock between 82 and 90, up to 8.00, less the 30 cents premium for the collar. 90 or higher stock called away, but have made 10%
Losses: of stock from 82 down to 75, or up to 7.00 (add the 30 cents premium for the collar) but protected below $75.
Rationale: Facebook has had a great run but has been going sideways for some time. Those that are long and would like to stick around through the next earnings should consider collaring stock. The short call does cap upside but a 10% gain on a market cap this big is nothing to shake a stick at, while that protection below should enable long holders to not worry as much about any massive downside moves.