Thursday, July 18th, 2019

Calls or Puts on Facebook


Now that the social media site has gone public with something of a flop, is it time for calls or puts on Facebook? Facebook stock has only been available for trading for a little over a month. The Facebook IPO went over $40 in the first hours of trading and then fell to less than $26 two weeks later. Today Facebook stock sells for around $32 a share. Does this slight recovery mean that Facebook is on the rise or is the thirty percent recovery in the last month temporary? That is the crux of the issue of whether to purchase calls or puts on Facebook. Can Facebook monetize its large following ? We wrote about this issue before the Facebook IPO flop. Long term investors will mull over the long term cash flow that Facebook can generate while day traders will follow market sentiment in search of profits. Options traders will consider calls or puts on Facebook depending on their own analysis. The advantages of buying options on Facebook stock are twofold. Traders can hedge their investment risk and enjoy a measure of investment leverage over buyers and sellers of Facebook stock. Owners of Facebook stock may consider selling calls in order to profit from holding a stock that may actually be going nowhere.

Volatility Encourages Options Trading

Buying calls or puts on Facebook stock is, by itself, part of risk management in options trading . However, options traders are flocking to the stock in high trading volume because traders and investors are still not sure just where the stock is likely to go. The current put to call ratio is about two to one which implies that the stronger consensus is that the stock price will fall over time. This is a new company and has been a fast growing one. Investors are willing to pay for growth but growth needs to translate into growth of profits and not just growth of customers. Long term, LEAPS, puts for January 2014 traded recently at just over $4.50 per hundred shares. The strike price of these contracts is such that a trader holding these contracts to expiration would break even at a stock price of $20.33 a share which is a third below the current stock price. The fact that traders are willing to buy such expensive puts on Facebook tells us that many who are holding Facebook stock are hedging their bets.

In buying calls or puts on Facebook stock the trader need not hold the contract to expiration. Rather he or she can sell the contract to reclaim part of the loss if the trade goes badly or collect a profit in the event of a well thought out trade. In addition a trader need lot limit himself to buying calls or puts on Facebook. With a long straddle options strategy an options trader can buy a call and a put on the same stock with the same expiration date. He gains if the stock goes up and if it goes down. His risk is limited to the price paid for the contracts. Also, he can both buy and sell a call or put on the same stock. The price received for selling the option can pay for the price of the purchased option. In this case the trader must watch the stock carefully in order to profit when the price move is as expected and exit with minimal losses in the case of a trade gone awry.

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