Facebook Stock and Overpriced Put Protection

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On Thursday July 26 and Friday July 27 I wrote a number of Facebook Stock articles. As regular readers know I have been Put Selling the Weekly put options against Facebook Stock for some time using the Shark Strategy.

I received a number of emails wondering what I meant when I said on Friday’s comment that I would not buy put protection on Friday. In my Facebook Stock article I was explaining that Facebook Stock was already so low Friday morning that put protection would be overpriced. Friday morning when Facebook stock opened up, anyone wanting to purchase put protection would be paying a huge premium simply because Facebook stock had fallen a long way on Thursday and everyone, including the market makers know that on Friday morning Facebook Stock is going to open down. Put premiums will always be pushed to extremes when the day starts like this simply because the market makers control the pricing and they know fear gets people to act impulsively.

Facebook Stock and Buying Protection on Friday July 27

The reason I indicated I would never buy put protection on a day like Friday is because I know from years of investing that when a stock plummets, option premiums are elevated to ridiculous levels and the market makers walk away incredibly happy. When I do buy puts for protection I always prefer to wait for the stock to bounce and recover some ground to reduce put premiums.

Let’s go over the movement in Facebook Stock over the 3 days, Wednesday July 25 to Friday July 27.

On Wednesday July 25 Facebook Stock closed at $29.34. On Thursday Facebook Stock closed at $26.85 a drop of 8.5%. However the way the media presented Thursday it was as if the stock was down 50%. The talking heads were doing what they do best and investors were watching and reading the dire reports. Market makers have done this for a long time and they know that on Friday morning the stock will open down, people will panic and they can clean up with overpriced options.

On Friday Facebook Stock opened at $23.19, a drop of 13.63%. Within 15 minutes Facebook Stock was down to $22.28 and then it began to climb. On the chart below I have marked the open as A and the high point for the day at $24.44 as B.

Facebook Stock Chart For July 27

Facebook Stock opened up way down first thing. Put premiums were overpriced.

Facebook Stock Options On Friday

On Friday I bought and sold a lot of August 3 expiry options on Facebook Stock . Here’s why:

Facebook Stock $22 Option

The range for the $22 Option On Facebook Stock for Aug 3

The range for the Facebook Stock  August 3 expiry options for the $21 put strike were overpriced. More than 6500 Aug 3 $22 put strike options traded. By 9:40 I sold 40 $22 August 3 Put Contracts for between $.55 and .65 cents. I bought all of them back starting around 12:30 PM for on average .12 cents. This includes buying back my Aug 3 $22 Facebook Stock puts which I sold on Thursday July 26 for .35 cents. You can read Thursday article about Put Selling Facebook Stock here.

Meanwhile the Facebook Stock August 3 expiry options for the $21 strike were also all over the place. More than 10,000 $21 put contracts traded. I closed my Facebook Stock $21 Aug 3 naked puts which I had just sold on Thursday for .20 cents, for .08. But investors could have sold these Facebook Stock  put options for .40 cents and bought them back later in the day for .05 cents.

Facebook Stock $21 Options

The Facebook Stock $21 Options were also all over the place.

Indeed even the Facebook Stock $19 naked puts for August 3 could have been sold for .20 cents. Strangely the Facebook Stock  $20 naked put could have been sold for just .05 cents more.

Facebook Stock $19 Put

The Facebook Stock $19 put traded for .20 cents while the $20 for only .25 cents

Investor Panic Provides Put Selling Opportunities

Frankly I was surprised by the volumes and the prices. In particular how easy it was to get filled on both the bid and then later in the day, the ask side.

In my article on Friday morning I felt that buying Facebook Stock put protection at the open was a bad idea. I explained that investors want to look for Facebook Stock to re-enter the Bollinger Band for put premiums to decrease in value. For those investors who bought protection right out of the gate, they overpaid. I received a lot of emails this weekend from readers telling me the terrible prices they paid. Instead if they had just watched the Facebook Stock  technical indicators on Friday morning they would have seen the oversold signal and waited for a bit of a bounce.

Below is the September 20 put which apparently a lot of investors bought at the open and paid $1.00. By mid-day they could have bought the same protection for 50% less. More than 4000 Put contracts were traded for the Facebook Stock September $20 put strike.

Facebook Stock September $20 put

Facebook Stock September $20 Put

The Facebook Stock $22 put strikes was equally a bad choice for those who bought protection first thing in the morning. More than 3600 put contracts traded. The big volume was on the September $21 put strike which saw 8850 put contracts traded.

Facebook Stock September 22 Put Strike

Facebook Stock September $22 Put Strike

Stock Technical Analysis on Facebook Stock

For investors who were determined to buy put protection on Facebook Stock, the simple use of the Ultimate Oscillator alone would have saved them 50% of the cost to buy put protection. By adding the Momentum indicator they could have guaranteed themselves on the direction of Facebook Stock from the open.

First thing in the morning the Ultimate Oscillator was flashing OVERSOLD. But you can see that the trend was already up within 15 minutes. Shortly after 12 o’clock, the Ultimate Oscillator indicated overbought. For those investor determined to buy protection on Friday and not wait for any possible further bounce in the upcoming week, that would have been the time to do it.

Momentum first thing in the morning showed the strength of the selling, but it did not fall lower. It opened down, stayed down until shortly after 10:00 AM and then rose. The important aspect of the Momentum indicator first thing in the morning was that it did not keep pushing lower. This is a clear sign that the plunge in the stock is not continuing.

Stock Technical Analysis on Facebook Stock

These simple tools would have saved investors buying put protection on Facebook Stock on Friday a lot of money.

Facebook Stock and the High Cost of Put Protection Summary

The plunge of Facebook Stock is not unique. It happens to various stocks every week. Some of my favorite stocks have experienced this including YUM Stock this year. What is important for investors is not to panic. For investors who wanted put protection, they should have bought it earlier in the week. But buying put protection when a stock plunges is often expensive for investors who fail to take advantage of stock technical analysis tools, as many investors found with Facebook Stock on Friday Morning.