Facebook Stock – WhatsApp Controversy and Put Credit Spreads VS Naked Puts For Weekly Option Selling

Facebook Stock is my speculative stock at the outset for 2013. I only do one spec stock at a time and last year I alternated between Facebook Stock and Lululemon Stock. When I last wrote about Facebook Stock I explained the strategy I have used to sell weekly put options against it. That was back on Feb 14. There has been a lot of controversy over the decision by Facebook to buy WhatsApp. As an investor it really does not benefit me to argue the case for or against this kind of capital outlay. Instead I prefer to look at the charts, find support levels and determine if my strategy can continue to provide me with the profits I am expecting.

As I sell weekly put options against Facebook Stock, my capital is at risk for just a short period of time. That said, decisions such as their buying WhatsApp can often lead to a stock falling further than anticipated and naturally impacting my returns. When you are selling naked puts for 25 and 30 cent gains and then find yourself having to buy back those same puts for a few dollars, it isn’t pleasant and it can really damage the trade especially when a stock gets unexpectedly pummeled.

At the same time doing nothing but put credit spreads against a stock like Facebook Stock often means I am selling higher put strikes to have reasonable returns with some protection. This article looks at two different investors and how they approach selling out of the money put credit spread options on Facebook Stock.

Facebook Stock Chart Outlook

Let’s first look at the chart and outlook for Facebook Stock. This afternoon with Facebook Stock down $1.25 put premiums are excellent especially after the WhatsApp purchase took the wind out of the recent rally. Investors are somewhat undecided and the stock at $70 is certainly trading at a very high PE of 107.9 times price to earnings and 71.9 times price to cash flow. Amazon stock which is trading at a whopping 601.5 times price to earnings is still trading at a lower price to cash flow at 44.9. It would appear that Facebook Stock is probably well ahead of itself. That means looking at support levels.

Presently there is some support at $60 and then more support at $56. But both of these levels are just reasonable support levels and that support could easily break in any kind of prolonged downturn in the stock or the general market.  The Ultimate Oscillator is showing the stock as being overbought since it reached $65 and the Slow Stochastic has been issuing sell signals since the stock was at $65. All of this impacts the volatility of the stock and the inflated price I am collecting from selling put options.

Facebook Stock Chart as of Feb 25 2014

Facebook Stock Chart as of Feb 25 2014

Facebook Stock – Put Credit Spread Versus Naked Puts

The Naked Puts

The strike level I sold today is down at the $66.50 level. The chart below shows the Feb 28 2014 expiry, put options at around 2:00 PM. I picked up 25 cents on my puts for a gain of .375 percent. I am not really shooting for a weekly percentage gain but instead I am aiming for dollar income. I sell 10 naked puts each time the weekly put options look decent but I like to stay out of the money by about 5% because Facebook Stock could easily dip 5% or more. I do believe though that I could easily defend a 5% drop in the stock.

Around earnings Facebook Stock could drop 10% or more which is why going into earnings I think a straddle or strangle is a better trade strategy to consider. .

At .25 cents on 10 contracts I am earning $250.00 a week before commissions or $13,000 by the end of the year if I can earn $250.00 weekly. Some weeks have been better but none have been less than 25 cents. I am keeping about $45,000 in capital and using margin for the rest of the trade. Because I am selling put options and not buying options, I do not pay for the margin use and as I have no plans to accept shares I will not be using margin at all. I would rather roll down or even outright take a loss when buying back my naked puts, than own Facebook stock.

Facebook Stock Put Credit Spreads

I have found with most investors who do put credit spreads that they often sell a higher put than I do as part of the spread. This obviously is to earn more on the trade since capital has to be spent to buy the protective or long side of the spread. Let’s look at two investors I know and how they handle their put credit spreads today.

Facebook Sock – Put Credit Spreads – Investor A

Investor A,  who does a lot of put credit spreads, this morning sold the $68 for .55 and bought the $66.50 for .25. His return then is higher than mine at 30 cents, but I think the spread is too wide considering he is selling the $68 which is less than $2.00 from where the stock is trading. Facebook stock could easily fall to below $68 but above $66.50 by this Friday. That would mean a loss for his position.

Facebook Stock Put Options Feb 28 2014 expiry

Facebook Stock Put Options Feb 28 2014 expiry

What he likes about his trade is the dollar amounts he can earn. For example he did 40 contracts on both sides. Without commissions he brought in $2200.00 income by selling 40 put contracts at the Feb 28 $68 put strike. 40 X .55 = $2200.00.

He then spent $1000 buying the $66.50 put contracts for the protective put. Total earnings was $1200.00.

Investor A looks at the trade that he has earned $1200 and risked $68 less $66.50 = $1.50 X 40 = $6000.00 for a return of 20 percent. He also points out that earning $1200 each week this way means he could earn $1200 X 52 weeks = $62400.00. This of course is in theory but I am using the dollar amounts to show the potential.

He likes the fact that he has earned $1200.00 and his total loss is limited to $6000 less $1200 = $4800.00. If by chance Facebook Stock should plunge below $66.50 the bought puts (long side) will of course earn more profit and could conceivably wipe out a $4800.00 loss. To wipe that out though the stock would have to plunge about $1.20 below $66.50 or down to $65.30. Still though I can certainly see his point and the trade benefits.

Facebook Stock – Put Credit Spreads – Investor B

Another investor friend is more conservative with his put credit spreads. Here is what he did today. He sold the $67.00 put for .28 cents and bought the $65.00 put strike for 13 cents. This earns him 15 cents.

If he did 40 option contracts (don’t know how many he actually did) this would return $520.00 or slightly less than half of what Investor A made. His risk of loss is set at $2.00 X 40 contracts = $8000.00 less $520 earned = $7480.00.  If Facebook Stock fell lower than $65, this investor would need the stock to fall to $63.13 by Friday Feb 28 to not lose on this trade.

However investor B is sitting much lower in Facebook Stock and therefore have a higher percentage of protection against a pullback from the stock by Friday Feb 28. If he could repeat this every week he would earn $520 X 52 = $27040.00 which is also a decent return. All of this is of course in theory but it does show the potential for returns in put credit spreads, even conservative ones, done in Facebook Stock.

Put Credit Spread VS Naked Puts Summary

I think after viewing the two types of trades I would be more likely to follow investor B and stay conservative and further out of the money. Both put credit spread positions have more protection than I do and both make sense on a stock like Facebook, especially when I have no interest in owning the stock at any time. Therefore I will be changing my naked put positions shortly in Facebook Stock and turn primarily to put credit spreads.

We will have to see what develops after this Friday’s options expiry. As Facebook Stock at present is my speculative stock trade, I will look towards other technical indicators to assist in timing when to sell put credit spreads and when to close them. I will post my work as it develops.

It is interesting though to see the two different strategies in use by the put credit spread investors. Both investors pointed out to me that following the WhatsApp purchase the stock is more volatile and could become much more difficult to sell naked puts against. They believe put credit spreads offers a potential of a decent return and better protection. I’ll be interested to see how some of my Facebook Stock trades turn out after this week ends.

If you have an opinion of which strategy you think is best for selling put options in Facebook Stock why not post it in the comments below. I am interested in all viewpoints.

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