Less than six months ago, traders were hoping for a chance to buy Facebook (NASDAQ: FB) the day the stock began trading. Some traders entered market orders to buy and paid $45 a share.
Since then, FB has been in a long downtrend and buyers who got in during early trading have losses of 50% or more if they are still holding the stock.[ad#Google Adsense 336×280-IA]Those positions could be just one of several bearish factors weighing on the stock price when earnings are announced this week.
The biggest indicator of bad news could be Google (NASDAQ: GOOG), which may have offered a preview of what FB will have to say after the close on Tuesday.
One analyst summarized Google’s disappointing quarter by noting that, “Google, the biggest seller of search-based advertising, hasn’t yet translated to mobile devices the success it’s had with desktop advertising.
Ads generated on smartphones can cost about 40% less than those on traditional computers and about 25% less than on tablets.”
Mobile users were one of the problems that FB noted last quarter. The company reported in recent SEC filings that growth in mobile use has been rising sharply. Almost 20% of Facebook users only access the social networking site from mobile devices, a trend that could have a significant, and negative, impact on FB as mobile use grows.
With concerns about its business model growing, it is not surprising that the trend in FB’s stock price has been down.
A potential double-top has formed in the stock with resistance from the top coinciding with resistance from the downside gap formed in July, near the time of the company’s first earnings release. This quarter could see a similar pattern if earnings or revenue disappoint, or if the company doesn’t offer comments indicating that the future will be brighter.
The double-top can be used to find a price target of $17.50. Traders can use options to increase their potential gains and manage the risk. Although it seems likely that FB will decline, this is a volatile stock and it could move higher, which would trigger losses for those shorting the stock. Put options will not eliminate the chances of a loss, but they will limit the risk to the amount of the premium paid for the contract.
November $20 put options are trading at about $1.80 and would have an intrinsic value of $2.50 at the $17.50 price target. That would be a potential gain of about 39% within the next two days.
If FB does rise on earnings, the share price is likely to experience a drop before the options expire when trading ends on Nov. 16. Between now and then, there will be a dramatic increase in the supply of FB shares.
After an IPO, insiders are generally required by the SEC to hold their stock for varying periods of time. The first big lockup expiration occurred in August when the supply of shares increased by about 15% and the price of FB fell about 6%. We’ll see another lockup expire at the end of October, which will increase the supply of FB shares by more than 10%, and likely cause further selling.
But the big news comes in mid-November. Two days before the November options expire, the lockup period on more than 1.3 billion shares ends. That will increase the amount of FB shares available by more than 50% and could trigger a price decline.
We could also see tax-loss selling from traders who bought in May. They will be facing losses on those shares and could claim a tax benefit by dumping them before the end of the year. Some may start selling in November, hoping to get a better price before the supply of FB stock grows.
In the short term, there is not much of an argument to be made by the bulls for FB. With the price likely to drop this week, put options could deliver a significant gain with a very short holding period.
Recommended Trade Setup:
— Buy FB Nov 20 Puts for $2.08 or less
— Do not use a stop-loss
— Set initial price target at $2.50 for a potential 20%-plus gain in less than a month
— Amber Hestla- Barnhart[ad#sa-generic]