On October 23, 2012 Facebook (FB) announced to the public and shareholders a special gift, a strong earnings announcement. Initially it seemed the market loved Zuckerberg’s gift with the stock gaping up 24% opening at $24.13. As a technician, I knew this was a gift to all the shareholders but I had to determine just what kind of gift it was. Was it a gift that would continue to give price appreciation in the coming days, weeks and months as the stock rebounded towards its IPO highs or was it a gift in the form of a opportunity to dump a losing position and head back to the safety of cash? My answer came shortly with the stock opening near the high of the day and fading throughout the day closing almost a full point lower at $23.23 on massive volume of 228 MM shares. It was clear the shareholders seized the opportunity to dump stock at these higher levels. This was NOT a vote of confidence!
As an option trader, I took this opportunity to sell the Nov 24/22 Bear Call Credit Spread and fade the trade. My expectation was that the sellers would continue to apply downward pressure on FB. As shares declined seller pressure would hopefully accelerate and more shareholders raced to get out before the stock dropped any more. If I were wrong and the stock rallied I would close out the position if FB traded above the 10/24 high of $24.25 and take my loss and move on… This strategy worked great as the stock traded down over the next two weeks on solid volume to a low of $19.13 on 11/09. I used a conditional order making adjustments with the downward movement to protect my profits and ride the trade towards expiration. The position never reached expiration. The conditional order closed out my spread as FB rallied on 11/14 locking in a decent profit (although not maximum gain).
I’m seeing another similar set-up today.
Yesterday (11/19) the markets rallied hard with the SPX up 2% and the NDX up 2.4% yet FB declined 2.71%. You’d be hard pressed to find a stock that did not participate in this broad based rally but FB certainly did not.
To my eyes, this is the start of a fade. On the previous trade I took a less aggressive position choosing to use the 24/22 strikes. In hind-site I wish I had been more confident in my analysis and selected a wider spread possibly the 25/20. This is the wonderful thing about being a spread trader, the ability to establish a position with varying degrees of risk/reward and probability to suit your own opinion and appetite for risk. I tend to establish more conservative position but FB has me running the numbers a little more aggressively than usual. Fortunately the recent rally has provided some key support and resistance points that we can anchor a trade to. The stock has pivoted found support on several occasions just under 19 yet never been able to trade higher than $24.25 since October 24 and July 30 prior to that.
Based on the chart evidence and my technical opinion that the stock will fail to achieve a price level greater than $24.25 and subsequently continue to fall back towards the $19 level; I’m highlighting a Bear Call Spread to take advantage of this technical trade. With FB at $23.04, up $0.12 this morning, sell the December 18 Call and buy the December 25 call for a net credit of $4.55.
With 33 days remaining I am anticipating a bearish move in FB back down to the mid 18 level but I’m going a little more aggressive using the 18 strike. I’m hoping some of the year end tax selling will help drive the stock past the previous support levels. The break-even point for this trade at expiration is $22.55* so I do have price performance pressure for this stock to drop. I am using a conditional (stop) order that states that if FB trades at $24.28 or higher to close out the spread. $24.28 is three cents higher than the highest trade on 10/24 on the wake of the strong earnings release. A trade higher could signify that large buyers have entered the market and I’d be best to take my loss and move on. This is a 7 point spread with a 4.55 credit so my maximum loss is $245 per contract which would occur at expiration if FB closed above $25. My maximum gain is $455 per contract which would occur at expiration if FB closed below $18.
This is an aggressive trade subject to a lot of market volatility, news driven price action, gap risk and all the drama associated with the pending Fiscal Cliff along with a absolute need for the stock to drop 22% in 33 days to achieve maximum gain. I suspect this trade will either close itself out quickly as a loser or slowly grind out some hard earned profits as the days to expiration tick away. Either way, it’ll be interesting to watch…. Trade smart, trade safe!!!
Rick and Shawn
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*Commissions and fees not included in calculations.