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4 Reasons Facebook is a Buy

The sentiment and technical backdrops look promising for FB

by 10/31/2012 12:03 PM
Stocks quoted in this article:

Although the Facebook Inc (NASDAQ:FB - 21.30) IPO remains one of the most lampooned market events of the year, the stock isn't down for the count. Growing skepticism among options players -- and three other factors -- suggest FB may have continued upside ahead, at least in the short term. The first lockup of FB stock expired Monday, meaning today is the first time employees can sell their shares since the mid-May IPO. So far, the stock dropped as much as 5.5% earlier but has already pared its losses considerably.

1. Bearish Options Activity

Bearish speculation has been building in the FB option pits, even in the wake of the company's positive earnings surprise last Tuesday. The put/call volume ratio tracking buy-to-open activity on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) stands at 0.85 for the last 50 trading days. Over the last 10 sessions, however, this ratio has ramped up to 1.40. In other words, a considerably higher number of puts have been purchased in the last two weeks as compared to the last 10 weeks.

Elsewhere, the equity's Schaeffer's put/call open interest ratio (SOIR) has risen nearly 11% since October options expiration and now stands at 1.53, just shy of an all-time high. This indicates a glut of put open interest among short-term options, which could translate into buying power as the bears capitulate.

2. Short Covering

Since early June, the number of FB shares sold short has surged by 116%. In the last month, however, this number has decreased by 16%. This suggests some short sellers have begun to head for the exits as FB exhibits strength. Further short-covering activity could lift the stock over the near term.

3. Positive Price Action

FB shares gapped 19% higher last Wednesday following the company's earnings news. This brought the stock solidly above its 60-day moving average, which had rebuffed previous advance attempts in late September and early October. Now overcome and beginning to turn higher, this trendline could reverse roles and serve as support. In fact, the stock's intraday low of $20.73 so far today approached this moving average, which rests at $20.44.

Daily chart of Facebook Inc (FB) since June 2012

4. Relative Strength

During the last 40 trading sessions, FB has outperformed the broader S&P 500 Index (SPX) by 21 percentage points. In the last two weeks, in fact, the stock has gained roughly 7.8% while the tech-rich Nasdaq Composite (COMP) has dropped more than 4% (and the SPX has shed about 3%).

A Volatility Note

Finally, it's worth noting that FB options are relatively inexpensive right now. Schaeffer's Volatility Index (SVI) reading of 53% is lower than 62% of the past year's worth of data. As expected, this reading has dropped sharply from pre-earnings levels of 76%.

The front-month, at-the-money (21.50-strike) straddle is currently priced around $0.75, or 3.5% of the stock's price. The options market is therefore essentially projecting a 3.5% move in the shares -- higher or lower -- by November options expiration in 2.5 weeks. Such a change would bring the stock to a level of $22.05 or $20.55, respectively.


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