Anatomy of a Trade – Facebook ($FB) Pokes Higher

by CC November 5, 2015 11:57 am • Education

Facebook (FB) is up 5%+ today on a favorable reaction to their Q3 earnings and forward guidance.

Yesterday we detailed a bullish stock alternative/replacement trade into the event. The trade defined risk to the downside and targeted the 110 level on the upside for November expiration. Here was the trade and rationale:

Stock Alternative/Replacement:

Buy the FB ($103.75) Nov 100/110/120 call fly for 3.45

Rationale – This is an excellent defined risk trade that protects against a sharp decline in the shares (in lieu of the risk of long stock here) while targeting a an upside move. The premium paid has a break-even slightly less than where the stock is trading, meaning it’s taking advantage of elevated implied vol into the print. The trade-off for this defined risk is that if the stock moves sharply higher on the event the profits trail off above 110 and are gone at 116.55 (where the trade actually starts to be a loser). The probability of that happening isn’t high but moves like that did happen in AMZN and GOOGL so it is possible. But chances are a realistic move higher and this trade does well, while defining risk in the event of a sell-off. The profits wouldn’t be immediately realized (similar to the TSLA fly from yesterday) but it’s a good risk reward.

As I said, the entire potential profits aren’t immediately realized the next morning, but it’s great risk reward with defined risk. Let’s check in on the trade and see how it played out. With the stock at 109 the fly is worth just under about $5.50. Not a double yet but intrinsically it has a lot of potential. The maximum value it can be is $10 with the stock at $110 on November expiration. At $109 the intrinsic value is $9. So the trade still has more than $3 in extrinsic premium yet to come in. Today, the theta of the trade is about 11c a day. That will accelerate as we get closer to earnings.

So for trade management this is one where you want to sit on it for a bit and see if the stock can settle near these new highs. You’ll want to keep a stop on it to the downside in case the stock reverses, if it does you may want to take profits. You can be patient to the upside and let it drift higher to 110 or slightly above as both vega (it is a short vol position) and theta would help profits the longer the stock stays near 110.