Wednesday, July 23, 2014

* Facebook (FB) - Earnings Preview: Lowest Risk Pricing Ever into Earnings... But it May Be Right... Or Not?

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FB is trading $70.76, up 2.2% with IV30™ down 1.4%. The Symbol Summary is included below.

Provided by Livevol

This is an earnings, stock and most importantly an earnings note.  This is a followup to a prior post:
FB - Transformation: This Isn't Social Media, this is a Giant of Technology. But Did You Know this About the Risk? I Didn't.

The risk into FB earnings is at the lowest level it's been... ever.  But there's a reason to believe that the pricing may be correct. There's also a reason to believe it may be incorrect.  I'll make both cases.

Let's start with the stock chart (all-time).

Provided by Charles Schwab optionsXpress

FB is up 85% since going public, and up more than 300% if we account for the initial dip in shares when the stock traded below $20.

Andre Sequin (at the time of RBC) made the call of a lifetime on live CNBC TV when he made a bullish call on FB in the face of growing skepticism. I went to high school with him so I get some of that credit by association (OK, no I don't).

The reality now is that FB is not just that app you like things on... that just ain't it.  FB is the 15th largest firm in the US (ish), and has now become a $181 billion market cap firm and it's way passed social media apps.

For the record, here is a smattering of firms that FB is now larger than:
  • Bank of America (BAC)
  • Citigroup(C)
  • Intel (INTC)
  • Disney (DIS)
  • Comcast Corporation (CMCSA)
  • Cisco Systems (CSCO)
The risk in FB shares should be dropping simply b/c of the fact that it is "not just that app where you like your friends". It's a GIANT of technology (see prior post at the top) which doesn't sway so easily to things like, how many people want to share BBQ pictures about July 4th.

But, it now lives in a world of fierce competition from GOOG, AMZN, AAPL, MSFT and really a lengthy list of other companies.  This is the Big Boy pool...

Let's turn to the IV30™ chart in isolation, below.

Provided by Livevol

The implied volatility is the forward looking risk in the equity price as reflected by the option market (IV30™ looks forward exactly 30 calendar days). In English, the red curve represents the future looking risk in FB shares.

But it's the earnings risk that interests me today.  The blue "E" icons represent earnings dates. Let's focus on those.

Provided by Livevol

Same chart, just earnings dates remain.

We can see that the risk level today is the lowest of any prior earnings release for the firm and oddly, essentially "tied" with the release in July of 2013.

So what happened on July 23rd / 24th 2013?...

FB gapped up from $26.51 to $34.36 or a 30% one-day rise.  The option market priced in a $1.90 move which is obviously substantially less than the realized ~$8 stock move.

That's the case for incorrectly priced volatility (too low) into earnings.

What about now?

Things have changed.  The market has come to a much clearer picture (for now) of the equilibrium value in FB.  Like it or not, it just ain't a $30 stock (at least not right now). The question becomes, is it a $70 stock?

The realized volatility in the stock has been rather low, in fact it was trading at this same level in March.  The unknowns are becoming fewer and fewer; clarity is growing.  That means risk "should" be lower.

That's the case for correctly priced volatility into earnings.

The answer surrounding earnings vol pricing will come out tomorrow (and later today in the AH trade). As for now, here's what the option market reads:

The Options Tab is included below.

Provided by Livevol

Using the at-the-money (ATM) straddle in the Jul 25 weekly options we can see that the option market reflects a price range of ~[$66, $76].

Using the Aug monthly options that range is ~[$64.30, $78.70].
  • If you believe the stock will be outside that range on expiry or any date before then, then you think the volatility is too low.
  • If you believe that range is too wide, and that the stock will definitively be in that range on expiration, then you think volatility is too high.
  • If you're not sure, and can make an argument for either case, then you think volatility is priced just about right.

This is trade analysis, not a recommendation.

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