Second Trade Update $FB – Taking Off Second Half For Almost 2.5x

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FB traded down to the 28 level on Monday, only to bounce back the past 2 days.  I am taking off the second half of my range trade today, mainly because the risk/reward is not longer skewed in my favor.  I am risking my current premium of 1.55 to make 1.45, and the trade won’t decay much for the next week even if FB doesn’t move much.  On top of that, LNKD reports tomorrow after the close, which might induce FB volatility, which I want to avoid.

ACTION: Sold to Close Second Half of FB ($29.10) Feb16th 33/30/27 put fly at $1.55 for a $0.91 gain

First Trade Update Feb 1st, 2013: 

After FB reported earnings yesterday, my range trade gained a good chunk of value as elevated implied volatility came down after the event.  I got a great question this afternoon from a reader:

Enis:
This is regarding your comment, when you reported the FB Feb13 27/30/33 call fly at .64, that it might become pinned at 30.
FB appears today to be pinned at 30. For the weekly closing 2/8, the largest call OI is the 30 strike.
However, for the monthly closing 2/15, the call OI increases progressively for each strike starting at 30, and bulging at 35.
Is there an interpretation attributable to OI that the UL may remain pinned through next week’s expiry, but become unpinned from 30 after that?
The fly bid today at ~ 1.50 is more than a double.
Past discipline exhibited here has been to take 1/2 off at a double.
I would like to know if the thinking for not taking 1/2 off is at all attributable to pinning, and whether the reasoning is generalizable.
Thanks.

My rationale for the FB trade has been that $30 is an important, round-number target for the stock.  It’s fluctuated on both sides of that level, but returned to it repeatedly in the last few weeks.

Having said that, I initiated the 33/30/27 fly for $0.64, and it’s now worth more than $1.50.  With the stock right at $30 today, and implied vol down to the mid-30’s in Facebook, I’m going to have to wait a while to capture more value out of this trade.  As a result, I’m going to take half off here, and leave the other half on for now.

ACTION: Sold to Close half of FB ($30.00) Feb16th 33/30/27 put fly at $1.52 for a $0.88 gain, remain long half

Original Trade Jan 14th, 2013: 

The Deutsche Bank analyst’s upgrade of FB to buy from hold this morning is a great example of the recent sentiment turnaround in FB.  His reasoning was that FB has “more revenue momentum” than expected, and his expectation for tomorrow’s event was for FB to show off a new search technology.

That’s all well and good, but where the heck was he 2 months ago when the stock was trading below 20?!?!

We became bullish on FB stock when everyone had left it for dead ahead of the November lockup expiry, with the stock trading around $21.  We felt that there were not many sellers left of the stock after 3 months of basing around the $20 level, and anticipated that buyers were waiting for the end of the lockup period to get the all-clear signal to finally buy the stock.  That did indeed turn out to be the case, though we did not trade that expectation as well as we could or should have.

In any case, looking at the situation today, all of a sudden everyone is now a Facebook bull with the stock above $30.  But one of the fundamental tenants of trading is that price determines risk.  It’s why we’re very careful about structuring our options trades to maximize our risk/reward and reduce our cost.  It’s why we’re reluctant to get bullish into euphoric situations.  And it’s why FB is a much riskier buy above $30 than below $20, in our view.  In that context, what’s the trade setup for today?

First, the stock has risen up to an area of technical resistance, where previous holders are more likely to unload stock.  Here’s the lifetime chart:

 

Screen Shot 2013-01-14 at 10.10.06 AM

 

 

The 33 area served as resistance several times last May and June.  If the stock spends some time digesting its gains over the next month, then the probability of a breakout above 33 would be higher in my view.  But given that the stock is up so fast in 2 months, I think sellers will start to overwhelm the buyers here.  While I expect a pullback, I don’t think it will be drastic, as the recent strength has been drive by mutual fund managers buying the stock (institutional ownership has been steadily rising), and that usually indicates some residual demand on any pullbacks.  The technicals point to decent support in the 27-28 area.

I also don’t expect a bad earnings report on Feb 1st.  Expectations were lowered enough last year, so I expect FB to likely beat.  But I do have doubts about the optimism surrounding tomorrow’s announcement.  Whatever is announced, the stock’s recent action seems to set up for a buy-the-rumor, sell-the-news event. There’s also alot of people that got plugged with stock on the IPO or bought it on the way down that will be sellers as the stock tries to go higher through the 30’s.

Finally, and most importantly, I decided on the following trade because of the setup in implied volatility, which I’ll explain in the Trade Rationale section below.

TRADE: FB ($31.30) Bought the Feb16th expiry 33/30/27 put butterfly for $0.64

-Bought 1 Feb 33 put for 3.25

-Sold 2 Feb 30 puts at 1.62

-Bought 1 Feb 27 put for 0.63

Break-Even on Feb16th Expiration:

-Profits between 27.64 and 32.36, max profit of 2.36 at 30

-Losses of up to 0.64 between 27 and 27.64, and between 32.36 and 33, max loss of 0.64 below 27 and above 33

 

TRADE RATIONALE:  The Feb implied volatility for FB is at 60 (on the upper end of its 40-70 range since IPO), and the earnings implied move for the stock is around 10-11%.  However, I think FB has its most stable investor base since the IPO, and also expect less volatility around earnings as the number of reports and visibility for the company increases.  But most importantly, the reason I like this trade is that I’m only risking 0.64 to make 2.36, and my profit range is within the 27.64 to 32.36 range, which seems like a good range based on the technicals going forward.  In other words, this trade is a good way of selling FB implied volatility, but at low risk.

I also chose to center the put fly around the $30 level since it’s an important psychological level for the stock, and a level that has a lot of option open interest, which might make a pin on expiry more likely.  Finally, the trade’s intrinsic value at initiation is around $1.70 with the stock at $31.30, whereas I’m only paying 0.64 for the trade.  I’m starting out ahead by about $1 on the trade, mainly because the options market has priced implied volatility so high.