Wednesday, October 30, 2013

Facebook (FB) - Update: Earnings Preview; Skew Bends Back Down; Did the Market Self-Correct a Bubble Before it Burst?

FB closed Tuesday trading at $49.40, down 1.7% with IV30™ down 1.7%. The LIVEVOL® Pro Summary is below.

Facebook, Inc. (Facebook) is engaged in building products to create utility for users, developers, and advertisers. People use Facebook to stay connected with their friends and family, to discover what is going on in the world around them, and to share and express what matters to them to the people they care about.

This is a quick follow up the article I posted on Friday 10-25-2013. You can read that post by clicking n the title, below:

Facebook (FB) - Reverse Skew; Upside Risk as Volatility Explodes and Stock Hits All-time Highs. Are We in a Bubble?

There was a fascinating phenomenon in FB skew. I've included a bunch of snippets from that prior article, below. But, let's start with the Symbol Summary from that day:

So we can see the stock slipping, and oddly, the volatility slipping even as we approach earnings.  Note that on Tuesday,the Dow as up 0.7% and S&P 500 was up 0.6% as the VIX rose 0.8%.

There was an unbelievably negative report out today on FB basically crushing it as an advertising platform, which IMHO was way overblown.  Here are some snippets:

Forrester, the respected market research group, has just published a brutal report on Facebook (FB) based on a survey of 395 marketing executives. The conclusion: "Facebook creates less business value than any other digital marketing opportunity ... [so] ... Don’t dedicate a paid ad budget for Facebook."

Facebook responded that the report was "illogical and ... irresponsible."

Source: Business Insider via Yahoo! Finance; Facebook is Doomed: Forrester Says Ads Tell a Sad Story.

I think the report fails to recognize that FB stock as been ripping b/c of mobile ads, not desktop ads. There's a lot more I find curious about the note, like a basic disregard for the entire marketing profession's ability to understand value in general and online marketing in specific, but I'll leave that to the reader.

The story I want to discuss is much more interesting (to me).  Here are some snippets from the prior post, and a dramatic change over the last two days to the phenomenon I wrote about.
Friday's Blog

We can see that the options recently hit an all-time high in the implied and are trading higher to any prior earnings release other than literally the first one after IPO. So, the option market reflects risk, right? Well, yeah, but not the kind you're thinking of...

Let's turn to the Skew tab as of Friday's close.

I have only included the Nov1 weekly options (earnings are due out 10-30-2013). So this is pure earnings volatility we see. And what do we see?...

Notice how the OTM calls are priced higher than the OTM puts. yeah, that's right, there is reverse skew in FB options reflecting greater likelihood of an upside move than a downside move. So, with the stock exploding to new all-time highs, this $126 billion market cap social media company is showing upside potential over downside risk in this earnings release. Whoa...

And is this "normal?"

No, on two counts.

1. Option skew normally shows higher volatility in the OTM (out-of-the-money) puts than OTM calls. You can read about what option skew is and why it exists by clicking on the title below:

Understanding Option Skew -- What it is and Why it Exists

2. More specific to FB, just look at the option skew on 7-24-2013 (the day of the last earnings release)

I know it's not the prettiest picture of all time due to some scaling issues, but this was a $26 stock ahead of earnings, you can see that strike price on the horizontal axis. Note how the strikes to the right (OTM calls) of ATM are flat, while the strikes to the left (OTM puts) are elevated. Yeah, FB didn't show this reverse skew last time. And more... the IV30™ into the last earnings report was 46%; today it sits just below 74%.

We're talking about hugely elevated risk, a decided upside bias in the option market and a ripping stock. You know what I call that?... A bubble... And you know what happens to bubbles before they burst?... they rise.

But today, my how things have changed. Let's look at the Skew Tab as of the close on Tuesday and once again the Skew Tab from Friday, below:



Note how that upside skew has bend down over the last two trading days.  In English, the upside potential that the option market reflected in the OTM calls has totally reversed. Now the OTM calls show lower volatility than the ATM options and in fact have started to even out with the OTM puts.

I tell you something else... I don't think it was this research report, I think it might actually be the market "self correcting" a bubble before it forms.  As I saw it last time, if the skew continued to rise to the upside and then FB stock exploded up on perhaps good but not unbelievable earnings (like GOOG did; you can read that post here: Google (GOOG) - Are We in a Bubble? Earnings Good, but Stock Hyper Reacts to Upside), then I felt like we were squarely in a bubble (no reverse pun intended).

I actually see this easing of the upside skew as a good sign for the broader market. Now, let's see what FB delivers on earnings and the stock reaction to that news.

This is trade analysis, not a recommendation.

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