This large social media company is set to announce earnings today after the close, however the share price is already down significantly in the last month due to fears related to the expected impacts of Apple’s new privacy changes. In our view, the impacts will be real, but this social media company will remain a long-term powerhouse, and the current situation has created an attractive high-income options trade. The trade strategy sounds complex (i.e. “bullish vertical put spread”), but it’s not. It puts attractive upfront premium in your pocket today, it gives you a chance to pick up shares of this attractive stock at a lower price, and it gives you a little insurance on the downside (i.e. your max loss is limited). We believe this is an attractive trade to place today—ahead of earnings.
Facebook (FB)
(Purple Line: Facebook share price)
The stock we are referring to is Facebook (FB), a company with more active users than others and a very high “average revenue per user” (see below). Facebook shares have sold off over the last month (see chart above) as investors fear the impact of Apple’s new privacy changes (read more here), however we believe Facebook will remain a powerful long-term juggernaut with growing revenue and high profits thanks to its massive reach—and regardless of the current Apple sitution.
Facebook announces earnings tonight right after the market closes.
The Trade: “Bullish Vertical Put Spread” on Facebook
Sell AND Buy Put Options on Facebook (FB) with a strike price of $300 (sell) and $225 (buy), and an expiration date of November 19, 2021 (roughly 4 weeks away), and for a net premium (upfront cash in your pocket) of approximately $4.44 (or $444 because options contracts trade in lots of 100). Your broker will make you keep $7,500 cash on hand (($300 - $225) x 100 (assuming you don’t want to use margin). The trade generates +5.9% of extra income over the next 4 weeks ($444/$7500). And this trade not only generates attractive income for us now, but it gives us the possibility of owning shares of attractive Facebook at an even lower price if the shares fall even further than they already recently have, and they get put to us (and we’d be happy to own Facebook, especially if it falls to a purchase price of below $300 (it currently trades around $325) but above $225 (if it falls below $225 we’d take the cash difference between our $225 strike put and the market price at expiration—this is basically insurance)). The trade may sound complicated, but it’s not, and your broker likely makes all the calculations and execution easy as you can see in the graphic below.
*Important Note: You will have to “work” this trade a bit as market prices and premium dollars are dynamic and constantly shifting. The goals is to select strike prices and premiums you are comfortable with, such as those we have described above.
Your Opportunity:
We believe this is an attractive trade to place today (before earnings) and as long as the price of Facebook doesn't move too dramatically before then, and as long as you’re able to generate premium (income for selling, divided by put sale strike price) that you feel adequately compensates your for the risks (currently 5.9% over the next 4 weeks).
Our Thesis: Facebook (FB)
Our thesis is simply that we believe Facebook is an extremely attractive long-term business (it’s basically a money-printing machine thanks to it’s high number of users, high revenues and very high margins), and we’d be happy to pick up shares at the lower price of $300, especially considering the share price has been floating lower recently (from a high of around $384) as the market fears what today’s earnings announcement might bring. We believe the market is overly fearful and this fear has increased volatility which has increased the upfront premium income available on this attractive trade. Regardless of the near-term price action/volatility, Facebook remains a very attractive long-term investment.
Important Trade Considerations:
Two important considerations when dealing with options contracts are earnings announcement dates and dividends. As mentioned, earnings is a big deal on this trade because it happens today after the close, and it is a big part of the reason the premium income available is so high (we expect the premium income available in the options market tomorrow to decline dramatically as the uncertainty of earnings will already be passed). Also, Facebook does not pay a dividend (if it did, we’d have to consider how that impacts the trade).
Conclusion:
When shares are weak in the short-term (as Facebook has been in recent months as the the Apple rule change has added uncertainty) volatility and fear are higher, and this causes the upfront premium income available in the options market to increase. And this has created an attractive trading opportunity, especially considering Facebook remains a very attractive business in the long-term (despite the recent share price weakness). In our estimation, these shares will eventually go much higher in the long-term considering its impressive growth trajectory and massive ongoing market opportunity.
Regarding the trade in this report, if the shares do get put to us at $300—that’s great—and we look forward to hanging on for the long-term. And if they don’t get put to us, we’re happy to keep the upfront premium income that this trade generates for us (we get to keep that income, no matter what). Furthermore, not only do we have a little insurance on this trade (we put/sell the shares at $225 if they fall below that level before the options contract expires), but the insurance piece also lets us enter this trade with a lower amount of cash set aside than if we just sold naked puts (for example, we’d have to keep $30,000 of cash in our account—to avoid using margin—if we sold naked puts with a strike price of $3,000). The big risk is that the shares fall all the way below $225 and we sell at that level. However, there are lots of ways to win. We like this trade and we like Facebook as a long-term investment—especially if we get the shares at a lower price.