Want to Own Facebook Lower – Check Inside: Aftermath

• Posted by Greg Harmon
• on July 28th, 2012

Saturday morning, I was asked how this went and how a holder would deal with this position now. This is really two questions. In the follow up below I provide the two answers that were just too complex for the comments field, along with the original piece as an introduction:

How would you like a chance to own Facebook 12% lower and still win if it rises on the earnings report? It is possible. The options market is pricing in a $3.50 cent move in the stock. You can take advantage of this by trading a Call Spread Risk Reversal. By selling the August 17 Expiry 24 Put for $1 and then buying the August 3 Expiry 27/30 Call Spread for 1.20, it will cost you 20c to have potential for a $2.75 gain next week and or own the stock at 24 on a pullback. Resistance comes into play at 30 as you can see in the chart below, so it will take a lot to leap over it. Not for everyone, but those waiting for it might as well have a shot at the upside too.

Trade: Buy August 3 Weekly 27/30 Call Spread and sell August 17 Expiry 24 Put for 20 cents.

The Proper Play

Like in the Hedging Options Gains After Hours – Case Study Mellanox Technologies strategy used, the play would have been to sell the stock short in after hours. An astute trader would have been able to sell the stock short at least in the 26.5-27.50 range, to hedge, after seeing the topping tails on the first 2 candles in the chart below (touching as high as 29) and bought at the leveling at 23.8 in after hours or held short overnight. Even at 26.50 this would have created a $2.70 gain if covered.

Facebook, $FB, 2 day 5 minute chart including afterhours and pre-market trading

The next day they would be presented with a decision of closing the short options position and stock or holding the hedge against the stock until a later date or expiry. Closing the short side of the position would have yielded a gain on the trade from anywhere between $2 to $3. Continuing to hold the short stock continues to hedge the short option. If you are put the stock it will close the short. A trader would likely hold the hedge until the stock shows signs that it has stopped falling and wants to rise, closing the short sale then. With no firm move higher by expiry, they would reassess the decision about whether to own the stock or not. Closing the short sale if they wish to be put the stock or both positions if they decide they do not want to own it.

Facebook, $FB, August 17, 2017 Expiry 24 Strike Put from Friday July 27, 2012

Play for the Trader that was at the Beach Friday

That is how it should have been played. But since the question was asked on Saturday, the Thursday night short sale is not available. If you took this trade and did nothing Friday, you now have a short August 24 Strike Put naked with the stock closing after hours trading around 23.80, with 3 weeks to go on the short option. Buying the option back to close the trade on Monday shows that if the price does not change it will cost about $1.35, locking in a $1.55 loss. The better play is to sell the stock short on Monday, to hedge the option. At 23.80 it would limit any loss to 40c. Using the same decision making as above, close the hedge if the stock shows a desire to move higher. As the stock went hard to borrow Friday it may not be possible to sell short Monday. First advice, get your short sell order in early Monday as brokers will likely have new stock but it will go fast. Second, look to hedge with options if that is not possible. Buy the August 3 weekly Expiry 24 Strike Put, which closed at 90c late Friday. Use the same stock price criteria to determine whether to take off the hedge or not, with the added step of continuing to look for stock to sell short from your broker. If you find it replace the option hedge with the stock hedge.

In both cases the trader should also look to sell the August 3 weekly 27 Call for what they can get, early in the week if the stock does not start higher, later if it does. If this leaves you with too much margin exposure, buy the weekly 30 strike back as well.

This is how we roll in the Premium Service. Options strategies, hedging and back and forth between premium users and myself. Come join us.

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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