Options Market’s Expectations on Facebook (FB) Earnings
Skew, Order Flow and Open Interest Considerations
Consensus: A Small Move or Move Higher
The heart of earnings season is upon us, and the release of these important quarterly reports brings potential volatility for stocks of companies that are reporting their numbers.
During earnings season, I break down what I see in the options marketplace for some of the most widely held stocks, such as Facebook (FB), Tesla (TSLA) and Alibaba (BABA), and send my analysis to my readers. While the options market is by no means a reliable indicator of how the stock will move, it is an important consideration in understanding the risks that the big market players see in earnings for each stock.
In my email to subscribers, I go through the inputs that tell the story that the options market is forecasting for earnings and summarize my thoughts.
Facebook (FB), considered one of the market leaders, will report earnings tomorrow evening after the closing bell, so I’ll use it as an example of the type of analysis I’ll write to my subscribers tomorrow.
Options Market’s Expectation on Facebook (FB) Earnings:
Facebook (FB) will report earnings tomorrow (April 22) after the closing bell. FB shares are up 6.50% year to date compared to 2.10% for the S&P 500.
The options market is pricing in a move of $4.80 this week for FB, or 79.20 to the downside and 88.80 to the upside.
Volatility, or the price of options, is elevated compared to the recent stock movement heading into Facebook’s earnings release. Below is a graph of volatility/price of FB options over the last 11 months. The “E” represents the day of earnings. As you can see, volatility (depicted by the red line) is low compared to previous earnings releases, signaling less fear of FB earnings relative to previous quarters. (Graphs courtesy of LiveVol.)
The volatility/price of options on FB is low compared to previous earnings releases, but in this environment, where a stock like ServiceNow (NOW) can drop 13% on earnings and Netflix (NFLX) can rip higher by 18%, a move of $4.80 is not out of the question.
FB shares have closed higher on earnings six of the last eight reports. Compared to the expected 5.7% move this week, in the past four quarters of earnings, FB stock has moved:
January 2015 earnings: 2.30% higher
October 2014 earnings: 6.07% lower
July 2014 earnings: 5.17% higher
April 2014 earnings: 0.79% lower
Based on the last year’s realized earnings stock movement, the options market is pricing in a move on the higher end of the ranges: the largest upside move was 5.17% higher, and the largest downward move was 6.07% lower.
Please note, volatility/price of options will get hit once earnings are released, as the unknown of earnings season will be known and traders won’t need insurance against large down moves or up moves in the stock.
Skew is the perceived risk of an extreme upside or downside move in the stock. In general, puts are bid higher than calls as most traders are long stock, so they buy puts and sell calls to protect their stock positions.
Here is a look at the skew graph of Facebook (FB):
The red line in the graph is the skew for options that expire this week.
The blue line is the skew for options that expire on May expiration.
The left side of the X axis are out-of-the-money puts, and the right side of the X axis are out-of-the-money calls.
The FB skew graph looks like most skew graphs as the options market is pricing in higher concern of the downside versus the upside. However, based on the chart, it appears the big market players are not concerned about a big drop as puts are not overwhelmingly expensive.
Order flow in a popular stock like FB is very hard to read, as FB is one of the most liquid options products, trading on average over 250,000 option contracts a day. However, in early trade today, calls are outpacing puts on a 3.2:1 ratio. Also, on 4/17, a trader bought 10,000 June 80 Calls for $5.00, a capital outlay of $5 million.
Open interest in FB options is skewed heavily bullish as it appears many traders are betting on further upside for FB in the days/months to come. Here are some call options that are heavily owned based on open interest figures:
30,000 May 85 Calls
22,000 May 87.5 Calls
21,000 June 85 Calls
42,000 June 90 Calls
35,000 October 95 Calls
20,000 January 90 Calls
40,000 January 100 Calls
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Facebook has received upgrade after upgrade in the last month:
On April 20, Oppenheimer reiterated an outperform rating on FB and raised its price target from 80 to 100.
On April 14, Brean Capital reiterated its buy rating on FB with a price target of 96.
On April 2, Citigroup reiterated a buy on FB and raised its price target to 97.
On March 27, RBC Capital set its price target for FB at 90.
On March 27, Barclays boosted its price target from 88 to 98.
Facebook has struggled for months to break out of its recent range. Since late March, FB has traded between 80.80 and 86, with 86 the 52-week high. This action is very similar to many growth stocks and the overall market, as they’ve bumped up to the high end of their recent ranges many times but continually get rejected.
The fact that FB option volatility is low compared to previous earnings cycles leads me to believe that the market is not expecting significant stock movement on earnings. Also, skew, or the potential for explosive downside or upside movement, is pricing a small likelihood of a large move in either direction.
Clearly, the major brokerage houses are overwhelmingly bullish based on their recent commentary and price targets. Also, the hedge funds and big traders have been accumulating sizable bullish positions based on open interest figures and recent option order flow.
While earnings are the great unknown, and the options market doesn’t always get it right, based on the many factors listed above, I expect either a small move, or a move higher for Facebook stock on earnings.
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Your guide to successful options trading,
Chief Analyst, Cabot Options Trader/Cabot Options Trader Pro
P.S. Learn how you can benefit from the information I provide to my subscribers about how the options market helps you forecast earnings. Don’t hesitate to try out Cabot Options Trader.