Hedge Idea – $FB: Poke Even Higher?

by Dan October 30, 2015 1:13 pm • Commentary

Let me start by saying my assumptions on Facebook (FB) for the better part of 2015 has been less than stellar.  On more than a few instances in the first half of the year I mistook the stock’s consolidation between $75 and $85 as investor concern over valuation.  Since the stock’s breakout to new highs above $85 I have considered $100 as important psychological technical resistance. The recent move above that resistance proves I was too pessimistic:

FB ytd chart from Bloomberg
FB ytd chart from Bloomberg

The move in the last couple weeks above $100 probably has less to do with Facebook, but has come more so in sympathy to investor excitement in growth stocks like AMZN & GOOGL that put up big Q3 results.

FB has had a massive year, up 32%, and just a couple percent from all time highs. But I think it is important to look back at Q2 results reported on July 29th and consider what the company said on their Q2 call.  Specifically that mobile ad growth rates will continue to decline, expenses are going up (op margins were down to 31% in the qtr from 48% the prior year), while daily active users came in slightly below expectations.  The stock briefly sold off as investors digested what was not unexpected news.

Next week is FB’s moment of truth, as they are scheduled to report Q3 results on Nov 4th.  The options market is implying about a 6% one day move which is rich to the 4 qtr avg of 3.25%, but shy of the long term avg of 8%.

Investors who have big gains in the stock, but don’t want to sell for tax reasons in 2015 may want to consider protecting gains into next week’s potentially volatile earnings event using a collar.

Three reasons to collar stock:
1. don’t want to sell your stock and pay taxes on gains.
2. want to protect against sharp decline
3. but also leaving room to participate in upside.

For example if you owned 100 shares at the current price of $102.50, you might consider buying the following overlay:

Buy Nov 110 / 95 Collar for Even Money

-Sell to open 1 Nov 110 call at $1.30
-Buy to open 1 Nov 95 put for $1.30

Break-Even on Nov Exp:
-Profits: of stock between 102.50 and 110 of up to $7.50 or about 7.5%, stock called away at $110, BUT if stock at 110 or higher you don’t need to be called away and can always buy back the short call.
-Losses: of stock between 102.50 and 95 of up to $7.50, or about 7.5%, but protected completely below $95 on your shares.

Rationale: One would overlay a collar vs long stock to protect against a sharp near term decline on a potentially volatile earnings event. With that protection you must be willing to give up potential gains.