Dan had a great preview of Facebook’s Q1 earnings due after the bell. Our view is that over the long term some of the same pain that they are causing their online competitors will eventually cause their own pain. But who knows when that day will come. So for now we’re fairly agnostic on the stock. But that doesn’t mean that shareholders shouldn’t be defining risk into events like this. As Dan mentioned:
And its earnings events and the corresponding conference calls (like tonight’s) are likely the moments to for any downshift in growth to be revealed, causing investors to rethink what they are paying for growth.
So let’s look at what to do with a long FB stock position. How can we protect these gains near highs, especially given what we’ve seen from MSFT and GOOGL near highs. The options are implying a move of about $8 in either direction. On the downside that take the stock to about $99. The 200 day moving average is above that at 101, and there’s an obvious psychological level at 100. So splitting the difference of all that, 100 is probably a good spot to target for where you want you disaster protection to start:
Hedge: Put Spread Collar
vs 100 existing shares of FB (107.25) Buy the 100/90 put spread & sell 120 call (cost 90 cents)
- Sell 1 May 120 call at .75
- Buy 1 May 100 put for 1.95
- Sell 1 90 put at .30
Rationale – This locks in gains in the stock below 99.10 down to 90 (90 is the 2016 low). It does mean being called away in the stock above 119.10 but that is an unlikely move on the event itself and the stock being that much higher than that is really unlikely so the chances of missing out on gains above 120 is low. Ideally the stock goes higher and this hedge just costs .90 or less than 1% of those gains. A move down to 100 or above and the hedge will have mark to market gains but the real protection doesn’t kick in until below 100. So consider this a way to lock in gains above 100 in case of a sharp selloff below 100.
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What about those that want to replace their stock entirely or wanted to get into FB stock while defining their risk in case this entry proves wrong on an earnings move lower?
Bullish play for previous highs:
Buy the FB (107.25) May 110/117/124 call butterfly for 1.30
- Buy 1 May 110 call for 3.50
- Sell 2 May 117 calls at 1.30 (2.60 total)
- Buy 1 May 124 call for .40
Rationale – This trade targets the previous highs and offers the potential for gains of up to 5.70 if the stock were to close at 117 on May expiration. Some risk exists if the stock were to go higher than the implied move as profits trail off above 117 and it actually becomes a loser above 122.70. But that’s a big move and is unlikely. The main point is this defines risk to just 1.30 (vs an implied move of 8.00) while offering a break-even on the upside of 111.30. If the stock were to go down with the implied move you limit your losses greatly, if it were to go up in line with the implied move you have gains (but a break-even of 111.30) and if the stock went no where you’d be fine and can just go back to being long stock with nothing much lost in premium spent (1.2%).