Options Action Meets the Zacks Rank

Facebook (for now) is the world’s number one social networking company. Their global reach and network encompasses roughly 900 million people and many Facebookers stay on for hours at a time. There is no doubt that they have a captive audience and a high level of participation among their users.

Interestingly enough, everyone and their mother wanted in at the IPO and now all of them are underwater and most are looking for the "dislike" button on thier holdings.

Despite the drop and uncertain future, there is still a lure to the company. Not because they are making tons of moneyor because CEO Mark Zuckerberg is the only executive that can wear hoodies to press conferences and get away with it. No, investors still support Facebook because of its potential to monetize the extraordinary amount, depth and accuracy of data that they have access to every millisecond. The NSA would be envious of Facebook's databases. Google may know what you like to wear; but Facebook knows what’s in your diary.

When Facebook figures out a way to monetize that data without overly disturbing their users and ruining their experience, that’s where they will win.For now they are still trying to figure things out; running regression models, programming adjustments and marketing tests to find the secret sauce.

The problem I see is that there will be many bad batches of sauce before they can even get close to one that’s perfect, if at all.

Zynga’s huge disappointment and subsequent 40% slice in stock price was blamed largely on Facebook, their algorithm and functionality changes.

Whatever you think of Facebook, I wanted to take a moment to review the fundamentals and let you in on what option traders are thinking in terms of an outcome tonight.

Zacks Rank
FB is a Zacks Rank #4 (Sell) and is currently trading at roughly 80 times 2013 earnings, which puts it in the “expensive” zone along with names like Chipotle (before their last earnings report) and Travelzoo when it was up at $95 per share (it’s now at $20). Sure these are completely different companies in different sectors, but growth is growth and if you can’t sustain it as a publicly traded company, your shares are going to feel it.

The Zacks Consensus Estimate is for the stock to earn 9 cents in Q2 with the most accurate estimate coming in at 5 cents, which gives this stock a NEGATIVE ESP of 44%. This essentially means that FB is not expected to “wow” investors tonight Although, the ESP of 0 is likely due to the fact that they pre-announced.

In the past 60 days alone we have seen estimates from for the current and next quarters as well as FY2012 and FY2013; this is also not indicative of strength.

Options Action
When you have a stock that has only traded for a couple months, it’s extremely difficult to determine a “normal” trading pattern of volatility. It’s common that options on new issues like FB will have extremely high volatility.

That is no exception here! In fact, ahead of the report the July options that expire tomorrow are trading at over 228% volatility. In layman’s terms, that would equate to a stock that moves roughly 14% a day on average!

When I look at the July straddle (call and put), it tells me that option traders are expecting at least a 10% move after tonight’s results.

There is also a moderately bearish bias today, even after the 6.65% haircut the stock received after Zynga’s report. The majority of action I saw today was in the July 25 puts (expiring tomorrow) that are expiring tomorrow; they traded almost 16,000 contracts before 1:00 eastern time. They were followed closely in volume by the July 30 calls (expiring tomorrow) which traded almost 15,000 contracts.

This could be a trader “collaring” the stock, which means they buy the 25 put and sell the 30 call against shares that they own. The trade can be put on for about even (no cost) and it offers the trader absolute protection below $25.

It’s a great little strategy, but is usually employed when a trader is scared of a drop.

Looking at the facts, I think that might just be the best choice in this case; because the Zacks Rank, the option pits and I all believe that FB could be in for a little pullback tonight.

I mightbe a buyer of Zuck's project at $22.00; but we will see what happens!

Notes:
Don’t ignore the underlying trends in the option markets. Options are often where the “smart money” does a great deal of trading because they can operate with a certain degree of anonymity.

Remember that this is not a guarantee of market direction, nor should you go and fire off a trade without conducting your own due diligence. I am simply breaking down the logic of the trade and putting the pieces together.

Just because someone buys 5,000 call options, doesn’t mean that they are bullish on the stock. Those calls could be purchased as a hedge to a very large short position or they could be only a part of a bearish spread that the trader is “legging” into. The trader could also be closing out an existing BEARISH position!

By combining options action with solid fundamental data like the Zacks Rank, it helps stack the odds in our favor of targeting the real direction and intention of the big volume option players.

Jared Levy is the Senior Equities Strategist for Zacks.com and editor of theWhisper Trader Service