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An Options Play on Facebook Which Should Make 50% in 60 Days:
Over the past month I have suggested legging into calendar spreads in advance of an earnings announcement for 7 different companies (FB, COST, TWX, TGT, SBUX, and JNJ, and ABBV). In every case, I was personally successful at creating a calendar spread at a credit and guaranteeing myself a profit no matter where the stock price ended up after the announcement. You should have been able to duplicate every one of these successes as well. I got a kick out of having 7 consecutive winning trades, some of which made me more than 100% on my amount at risk.
The ultimate gain on these spreads will depend on how close the stock ends up to the strike price of my calendar spread after the announcement. The nearer to the strike, the greater the gain. It is fun owning a spread that you are certain will make a profit, no matter what the stock does.
Today’s idea is a little different. We will not be guaranteed a profit, but it looks quite likely to happen if our assumptions hold up. In each of the last two quarters when FB announced earnings, they were better than the market expected, and the stock rallied nicely. Who knows what will happen next time around when they announce once again on July 27?
If history is any indication, the stock price for FB doesn’t fluctuate very much between announcement dates. It tends to be fairly flat, or edges up a bit in the lulls between announcements, and often moves a little higher in the week or two before the announcement day.
Today, I bought these calendar spreads on FB when the stock was trading just about $120:
Buy To Open 2 FB 16Sep16 120 calls (FB160916C120)
Sell To Open 2 FB 15Jul16 120 calls (FB160715C120) for a debit of $3.26 (buying a calendar)
Buy To Open 2 FB 16Sep16 125 calls (FB160916C125)
Sell To Open 2 FB 15Jul16 125 calls (FB160715C125) for a debit of $3.11 (buying a calendar)
My total investment for these two spreads was $1274 plus $10 commission (at the rate charged to Terry’s Tips subscribers at thinkorswim), for a total of $1284.
Here is the risk profile graph which shows the profit or loss from those trades when the short options expire on July 15th:
You can see that if the stock ends up somewhere between $120 and $125 in two months, these spreads will make a gain somewhere near $550, or about 42% on the original investment. I think the stock is quite likely to end up inside this range. If I am wrong, and it falls by $5 or goes up by over $10, I will lose some money at that time, but in each case, the loss would be less than half my expected gain if it ends up where I expect it will.
As encouraging as this graph looks, I think it considerably understates how profitable the trades will be, and that has to do with what option prices do around earnings announcement dates. Since stock prices tend to have large fluctuations (both up and down) after the results are made public, option prices skyrocket in anticipation of those fluctuations.
When the 15Jul16 options expire on July 15, there will be a weekly options series available for trading that expires just after the July 27th announcement. It will not become available for trading until 5 weeks before that time, but it will be the 29Jul16 series.
Implied Volatility (IV) of the 15Jul16 series is currently 26 and the 16Sep16 series has an IV of 30. When the 29Jul16 series becomes available, IV will be much higher than either of these numbers, and should soar to near 60 when the announcement date nears (it grew even higher than that a few weeks ago before the last announcement). An IV that high means that an at-the-money call with two weeks of remaining life (which the 29Jul16 series would have when the 15Jul16 series expires), would be worth about $5, or almost double what the above calendar spreads cost us. If this were true, and if the stock is trading between $120 and $125, you could buy back the expiring 15Jul16 calls and sell the 29Jul16 calls at both strike prices for a credit which is greater than what you paid for the original calendar spread, and when those short calls expired, your long calls would still have 6 weeks of remaining life.
In other words, the strategy I have set up today by buying the above two calendar spreads is an admittedly complicated way to leg into two calendar spreads at a large credit, and guaranteeing an additional profit as well. The risk profile graph doesn’t reflect the fact that IV will soar for the 29Jul16 series that doesn’t exist yet, and the indicated gains are drastically understated.
I will update these trades as we move forward, and let you know if I make any adjustments. If the stock moves up to $125 in the next few weeks, I would probably add a third calendar spread at the 130 strke. That is about the only likely adjustment I can think of at this point, unless the stock falls to $115 when I would probably buy the same calendar spread at the 115 strike.
If you make this investment, as is true with all options investments, you should do it only with money that you can truly afford to lose. If you do choose to make it, I wish both of us luck over the next two months.
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Any questions? I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts. seth@terrystips.com
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I look forward to having you on board, and to prospering with you.
Terry
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