OPTIONS

This week marks another first for the social networking giant as Facebook (FB) options make their debut, and there are a few different strategies traders and investors can put to use, explains Mike Scanlin of BornToSell.com.

Option exchanges have minimum requirements that must be met before new issues like Facebook (FB), or any stock, can trade put and call options:

  1. Share price above $3 for five business days
  2. Number of shareholders greater than 2,000
  3. Public float in excess of seven million shares
  4. 12-month trading volume greater than 2.4 million shares

Facebook has met all of these requirements and will have call and put options available on Tuesday, May 29.

Initial strikes on FB will be 16, 19, 22, 25, 28, 31, 34, 37F, 40, 43, 46, and 49, and the options will trade in nickel increments.

Facebook Option Strategies for Various Investor Situations

There are different strategies for investors in different situations. Let’s start with the most vested to the least:

Employees and Early Facebook Investors

You probably have a share cost less than the current market price of $31.91. Maybe you don’t want to sell your shares (or can’t, because of the post-IPO lockup), but you’d like to generate some income from your shares. This is a classic use of covered calls. Set the strike price as high as you like, and just write near-term call options against your position. It’s found money, and if you’re not doing it, you’re leaving money on the table every month.

IPO Investors

You were allocated shares at $38 in the IPO. Now they’re at $31.91. How do you recover?

In any repair situation, you have to first ask yourself if you still like the stock. If you were just hanging around for a quick flip on a new issue, then you should have gotten out by now. If you haven’t, and if you still like FB more than some other stock you could buy, then a common stock repair technique is to buy one at-the-money option for every 100 shares you have, and sell two out-of-the-money options to pay for the purchase.

Example: You own 100 shares at $38. It’s now at $31.91. Buy one 34-strike call for $2, and sell two 37-strike calls for $1 each (all three have same expiration date). You’ve lowered your breakeven point from $38 to $36 for zero additional dollars:

chart
Click to Enlarge

You’ve also put a cap on your upside, though. Best you can do is have FB be $37 or higher on expiration day (in which case you make $2 per share). If it shoots up to $45, you will only make $2 per share on your original investment of $38 (but, hey, this is a “repair” strategy whose goal is to lower your breakeven point and get you out of a losing position).

See also: Would You “Fix” This Option Trade?

Post-IPO Investors

You bought shares after the IPO. No matter what you paid you are underwater since FB closed at its low on Friday.

This is basically the same case as the IPO investor who bought in at $38. If you still like the stock, use the repair strategy to lower your breakeven point. If you no longer like the stock, then just sell it, take the loss, and move on to something you like better.

As an alternative, you could write covered call options against your stock with a strike equal to (or greater than) the price you paid. If called, then you’ve made something; if not called, then you’ve lowered your breakeven by the amount of premium you received and you can write another covered call for the next option cycle. FB is unlikely to go to zero, and eventually you should be called away (for a profit, if you keep your strikes equal to or greater than your adjusted cost basis).

Not Currently a Facebook Investor

You don’t own FB but are considering doing some buy-writes once call options begin trading.

In this situation, you have to consider FB next to all of the alternatives (i.e. other stocks you could do a buy-write with). If the option premiums are very good on FB, and if you keep your position size reasonable, and your “moneyness” as deep as meets your risk profile, then this could be a decent candidate for buy-writes.

However, like other recent Internet IPOs like Groupon (GRPN), LinkedIn (LNKD), Yelp (YELP), Zynga (ZNGA), and Pandora (P), you will want to keep your position size modest. High volatility is good for option premium, but bad for portfolio value if the stock moves against you.

By Mike Scanlin of BornToSell.com

Tickers Mentioned: FB, GRPN, LNKD, YELP, ZNGA

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