From the questions I receive, I’m aware that a decent percentage of my subscribers have stock and/or options positions in a handful of stocks, including Apple (AAPL), Facebook (FB) and Alibaba (BABA). These companies are all reporting in the coming days, and because of your interest in these stocks, I will dig a bit deeper into what the options market is “projecting” for each stock.
Facebook (FB) will report earnings this evening after the closing bell. The stock is trading unchanged today at 95, as the market is trading marginally higher. For the year, FB is up 22%.
Expected Move/Volatility
The options market is pricing in a move of $8.00 this week for Facebook, or 87 to the downside and 103 to the upside.
Volatility is extremely high headed into this evening’s earnings release. Below is a graph of volatility/price of FB options. The “E” represents the day of earnings. As you can see, current volatility (depicted by the red line) is slightly higher compared to previous earnings releases.
FaceBook Volatility
While the volatility is high, in this environment, where Google (GOOG) can gain 16% on earnings, and Netflix (NFLX) can pop 18%, a move of 8.50% is not out of the question.
In the past four quarters, Facebook stock has moved by the following percentages after the company’s earnings were released:
April 2015 earnings: Lower by 2.62%
January 2015 earnings: Higher by 2.30%
October 2014 earnings: Lower by 6.07%
July 2014 earnings: Higher by 5.17%
The average closing move for FB over the past six quarters is approximately 5%—3.5% less than the expected move this week. The largest upside move in the past six quarters was 14% in January 2014, and the largest downward move was 6% in October 2014.
Note that volatility is extremely high, and buyers of calls/puts will see dramatic loss of value in these options if the stock doesn’t make a large move in the trader’s preferred direction.
Skew
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:
The red line in this graph is the skew for options that expire this week.
The blue line is the skew for options that expire on August 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.
This is about what I would expect from Facebook skew graph into earnings. Volatility is high everywhere in FB options, so the extreme puts and calls are high, just like the options closer to the current stock price. That’s why the graphs look so flat.
Order Flow
Order flow in a popular stock like Facebook can be a challenge to read as the stock trades approximately 260,000 options per day. That said, as you’d expect with a stock as loved as FB, order flow has been overwhelmingly bullish for quite some time.
Yesterday, a trader put on a MASSIVE short-term bullish position when he bought 12,000 July 97.5/107 Bull Call Spreads and Sold 12,000 July 87.5 Puts (exp. 7/31). This is a bull risk reversal, and is an extremely bullish and “gutsy” trade heading into earnings with the potential to be forced to buy 1,200,000 shares at 87.5.
Open interest in Facebook 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 a couple of options that are heavily owned based on open interest figures:
- 32,000 August 95 Calls
- 33,000 September 100 Calls
- 40,000 December 110 Calls
- 70,000 January 100 Calls
- 25,000 January 110 Calls
Conclusion
Volatility in growth stocks on earnings is getting to extreme levels. In the last several weeks, Netflix, Google and Amazon all went crazy to the upside. Today, Twitter, Yelp and Tableau Software are crashing to the downside. Likely due to these recent moves, Facebook options are extremely expensive.
The brokerage community is overwhelmingly bullish on Facebook, and hardly a day passes without a new price target well above 100. Likewise, order flow and open interest has been skewed massively bullish for the past month.
FB has been on a big run since early July, and has gained approximately $10 this month. It’s always an interesting situation when a company runs so hard into earnings. While most traders assume Facebook’s numbers will be blowout and the stock will break 100, it’s also possible that the market has already priced in strong earnings.
As I’ve stated, FB options are extremely expensive, but so were AMZN, GOOG, TWTR and DATA options, and it turned out they were actually extremely cheap.
If you want to put on a SHORT volatility trade, you could:
- Execute September 95 Buy-Writes (big downside risk if stock falls apart, but you are selling high volatility)
- Sell September 85/82.5 Bull Put Spreads (profits above 85 on September expiration)
- Sell September 85/82.5 Bull Put Spreads and sell September 110/115 Call Spreads (an iron condor that makes money between 85/110 on September expiration)
If you want to put on a LONG volatility trade you could:
- Buy August 95 Call and August 95 Put (long straddle that will lose lots of value if the stock doesn’t make a big move)
- Buy September 97.5 Calls (long volatility risk)
- Buy September 92.5 Puts (long volatility risk)
Playing earnings in a name like FB is a bit of a gamble for both long- and short-volatility trades. On the short-volatility side, if the stock makes a big move, it can be extremely painful. On the long-volatility side, if the stock does not make its expected move, it will also be extremely painful. Because of this, I won’t gamble and play FB earnings.
I am not recommending the strategies listed above, but if you have any questions about these strategies, don’t hesitate to email me with your questions.
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