FB – “Making More Humans (hard even for Facebook)”

by Dan August 10, 2016 1:06 pm • Trade Ideas

Facebook’s (FB) $358 billion market cap (just a tad from its recent all time highs) has catapulted the social media company to now be one of the top 10 most valuable companies in the world, just a few billion dollars below Exxon (XOM). Just to put this comparison in some valuation context, XOM paid $3.1 billion in dividends to shareholders in Q2. That’s nearly equal to half of FB’s quarterly revenue. And XOM’s Q2 revenues of $57 billion were more than 2x FB’s expected 2016 revenue of $27 billion. Of  course it’s an apples to oranges comparison in so many ways. FB is growing annual sales at 50% and inventing ad dollars out of thin air. Meanwhile, XOM’s exploration and production of oil remains a costly endeavor.  The only point here is to put into some context what is being paid for FB by investors, and the fact that one of the largest stocks in the world is trading at nearly 14x its expected 2016 sales and trades at nearly the same market cap as a company that returned more money to shareholders in the trailing 12 months than FB booked in total sales.

Facebook the company and its stock are blessed with the sort of unusual optimism by the press, users, Wall Street analysts and investors that has only been reserved for a very small group of  companies in very special times. We may be in one of those special times. But one thing is certain, even special companies are not immune to corrections.

Look at Apple (AAPL), the shiniest of special things in the stock market over the last 1o years. From Sept 2012 to April 2013 it had a peak to trough decline of 45% and even more recently had a 33% peak to trough decline from April 2015 to May 2016. In both instances it lost more than $100 billion in market cap, despite remaining the undisputed leader in its core business throughout:

From Bloomberg
From Bloomberg

Your guess is as good as mine as to what “that thing” will be to cause the big one of corrections in FB shares, and from where.  Former Facebook employee, Antonio Garcia Martinez author of the WSJ & NYTs best seller Chaos Monkeys: Obscene Fortune and Random Failure in Silicon Valley* pointed to the simple math that could eventually halt the company’s global domination and its stock’s advance. From page 352, (chapter titled Monetizing the Tumor):


In Facebook’s Q2 report on July 27th the company revealed a year over year increase in monthly active users to 1.71 billion, an increase of 15%, an acceleration from Q1’s 13% increase. For now, that’s one big reason why the stock has been able to levitate very near its post earnings all time highs.

All that said, I think it makes sense to look closely at the post earnings price action of the stock in the last year. Following the last three earnings reports (excluding Q2 last month), the stock has seen initial sharp rallies (with two out of three) causing the stock to make immediate new all time highs with the outlier in January (Q4) still achieving new highs in a matter of days.  In all three instances the stock backed off from those highs in the weeks following. The largest pullback was in November (Q3) from a then all time high, where the stock subsequently gave way to a 19% decline to its Jan lows. The January (Q4) post earnings decline from a then all time high was nearly as big, resulting in a 17% decline to its February lows. The late April all time highs post Q1 earnings was followed by a 10% decline to its late June lows. You get the point. But even knowing those almost predictable pullbacks, the chart shows what is plainly obvious in that the stock continued to make a series of higher highs and higher lows. This is a healthy stock chart to say the least:

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

But with FB once again at all time highs, playing for a pullback to the uptrend, which is also very near the 200 day moving average at $111 may look like an attractive bet for traders.  And with short dated options prices at their lowest levels ever (30 day at the money implied volatility is at 17.3%), long premium directional trades look attractive:

FB 3yr chart of 30 day at the money implied volatility from Bloomberg
FB 3yr chart of 30 day at the money implied volatility from Bloomberg

So What’s the Trade?  

While options prices look cheap, we are in a fairly slow moving market in the dead of summer, and owning even cheap options could prove to be expensive even if one is gets the direction right. To help offset decay one might consider calendars, or butterflies. In this instance I like a put butterfly to play for move in the next 5 to 6 weeks back towards the mid teens in the shares:

*Trade: FB ($124.85) Buy Sept 125 / 115 / 105 Put fly for $2
  • Buy to open 1 Sept 125 put for $2.85
  • Sell to open 2 Sept 115 puts at 50 cents each or total $1
  • Buy to open 1 Sept 105 puts for 15 cents

Break-Even on Sept expiration:

Profits: between 123 and 107 make up to 8, max gain of 8 at 115

Losses: up to 2 between 123 and 125 & between 105 and 107 with max loss of 2 below 105 or above 125

Rationale: This trade has a potential payout of up to 8 on risk of 2. It starts basically at the money, and has a break even just below in the stock of 123. It defines a profitable range between 123 and 107 which means any pullback similar to those in recent history means this range is well positioned. A stop on the upside of about 50% of premium paid is the way to stay disciplined.

*I really enjoyed Chaos Monkeys, specifically the professional journey of the author. He starts his career at a Wall Street bank, winds up knee deep in the Silicon Valley startup scene in the aftermath of the Financial Crisis on his way to running and advising ad businesses of two of the largest social media platforms.  The book is not the answer key to the next $100 billion market cap move of Facebook’s stock, but it does give a great deal of insight into how decisions get made by management inside the social media behemoth, most of whom are still pulling the strings. It also details many of the company’s early successes and failures that have made the company the on-the-line advertising juggernaut that it is today.