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Facebook Inc (NASDAQ:FB) has struggled to move higher after reporting earnings on July 26. FB stock traded up to the $175 level following a profit beat, but has since pulled back and struggled to make any significant headway.
Given that Facebook stock is already up more than 50% year-to-date and is starting to look a little tired from a technical analysis perspective, I expect shares to pull back over the coming few weeks.
Facebook’s second-quarter earnings report was certainly solid, with EPS coming in at $1.32 per share versus expectations of $1.13. Revenues, however, beat by a far more modest amount ($9.32 billion actual versus $9.2 billion expected). Revenue growth also slowed dramatically, to 44.7% year-over-year compared to 59% for the same period in 2016.
The social network also warned that it was running out of room to show ads on the News Feed, which should temper revenue as well. Facebook now has just over 2 billion monthly active users (MAUs) and 1.32 billion daily active users (DAUs), so there’s a worry about how robust user growth can be with such already large figures.
From a trading perspective, the post-earnings reaction in FB stock was certainly telling. Facebook pulled back decisively after trading up to the $175 level. This type of price action is many times emblematic of a top in a stock. The 9-day Relative Strength Index (RSI) indicator is reading overbought, and MACD is poised to generate a sell signal on any additional weakness.
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Facebook stock also is getting a little stretched fundamentally. FB now sports a market cap of roughly half a trillion dollars, making it the fourth-largest U.S. company. The price-to-earnings ratio of 43 is in relative nosebleed territory, especially given the size of Facebook and slowing growth rates. I expect the P/E multiple to begin to contract for Facebook, providing a definite headwind for any further price appreciation.
To position for a pullback in Facebook, a call credit spread trade makes sense. Option prices, as gauged by implied volatility (IV), are in the 48% percentile, so option selling strategies continue to be very viable.
How to Trade FB Stock
Buy the Sep $185 calls and sell the Sep $180 calls for a 60-cent net credit.
Maximum gain on the trade is $60 per spread, and maximum risk is $440 per spread. Return on risk is 13.63%. The short $180 strike is positioned well above the $175 resistance level and provides a 5.12% upside cushion to the $171.23 closing price of FB stock.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at firstname.lastname@example.org.
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