Last week Facebook (FB) gave us an ideal case study in which to analyze the inner workings of options and the options market place during an earnings release. FB was scheduled to release earnings post market Wednesday, May 1st. Knowing that earnings would be highly watched and scrutinized by both retail and institutional traders I started to document through screen shots the “Tale of the Tape” Friday April 26. I wanted to document the actual (non theoretical) affects of volatility, time and movement on option pricing. Most beginning option traders will buy at-the-money or out-the money contracts and I wanted a real world case study to use for my clients to show why this isn’t the best way to trade earnings or how to use a Weekly. I’ll review a few key points from each of the screen shots that I found interesting. In the option chain below taken Friday April 26 mid-day notice that FB last traded at $27, up 3.29% on the day.
At this point there are 3.5 trading days left prior to earning and 5.5 days remaining in the life of the May 3 Expiration Weekly options. Look at the 27 strike for both calls and puts. You’ll see the Ask for each is $1.26. Since the stock is at $27 and the strikes are at 27 these contracts are At The Money with zero intrinsic value. Therefore, the $1.26 is all Extrinsic value (hope and time). In this case and under these situations hope and time are worth 4.67% for 5.5 trading days. Regardless of what direction a trader might feel the stock is going to move, it’ll need to move 4.6% in that direction at expiration to break even. Since FB is still a new issue there is not a great deal of post earnings price history. Post earnings opening moves were: -13.7%, +23.7% and -6.97%. A 4.6% move might have seemed insignificant and even a Long Straddle at $27 might have seemed like a viable trade requiring a 9.2% move to pay for itself.
Take a look at the screen shot below. It was taken 8 minutes after the opening on Thursday May 2, as I wanted there to be enough volume for a clear analysis. The earnings after the close on May 1st were well received. The shares have moved from $27 to $28.42.
What I like about this screen shot is the fact that both calls and puts are showing a Net Change in the red despite the stock being up 3.61%. The Call volume is significantly higher than the put volume but the numbers are a clear example of a Volatility Crush sucking out all the “juice” from both the calls and the puts. The $27 call is only up .$0.20. Being that this option is now In-The-Money a novice trader would be expecting a move based on Delta alone of around .65. Note that the stock is up $1.42 from the screen shot from April 26 and the $27 Call option is up only $0.20! A trader that does not understand the implications of Vega would think they were being “short changed” by the market maker.
The final screen shot was taken right at the close Friday May 3. Note that the stock is now $28.32 which is just 0.10 lower than the screen shot taken on 5/2. The 27 call option which could have been purchased the week prior for $1.26 is now worth $1.32 and the stock is higher by 4.8%. After commissions this trade would be a zero sum gain.
There are a lot of moving parts to these screen and many lessons to be learned. Most beginning option traders buy long calls and long puts. They understand that if they buy a call and the stock goes up, they will make money. If they buy a put and the stock goes down, they will make money. In the case of FB, the stock went up 4.8% and most call buyers didn’t realize a profit. Learning these lessons the hard way is often an opportunity to explain why and how.