Facebook

         Facebook is a great company but recently the performance of its stock price has struggled. As an investor that wants to retain the upside that FB offers with out the risk of a declining value of the stock I recommend to use a protective put. The current price of Facebook is at $147 a share. The earnings report will be released tomorrow and the investor is worried. In order to avoid the risk of the price of the stock decreasing due to the earnings call tomorrow, a put can be used to avoid losing value in your asset. As the price of a share of FB decrease the value of your long put will increase the same amount. The cost of the put is $5.45 a share and expires two days after the earnings report. You should view the protective put cost as insurance. Based on the return of the stock you would realize a profit of the stock price minus $5.45 if the price stays at $147 or increases. If the price of the stock declines you will be assured a return of $141.55. The down side of this strategy is the cost of the put will not be recovered if the put is needed and the stock price will have to hit $152.45 to break even as if FB remained at $147 without the put. The upside of the protective put is the insurance that if Facebook reports bad earning the combined value of the put and stock will not fall below $141.55, accounting for the cost of the put.

      After reviewing Facebook's options for a client to protect there investments the long term upside of the stock intrigued me. I want to avoid investing all the capital to own a share of FB and so I started to calculate the value of long-term out of the money call options. A call option with an exercise price of $350 and an expiration date of June 19th, 2020 is worth $0.84 using Black-Scholes Model. Using the same volatility a call with an expiration of January 15th, 2021 and exercise price of $250 is valued at $7.66. The Black-Scholes Model calculated previously used historical volatility for the previous year, using implied volatility the options are valued at $0.78 and $7.70 respectively. The implied volatility is 33% to arrive at $0.78 and $7.70 option prices.

    To forecast the return of the options lets assume Facebook increase to $250 in exactly a year. The price of the call that exercises at $350, lets refer to as option A  is now worth $4.11 and expires in 7 months. The return on the option would be 426% if you sell at this point. If you bought the option that exercises at  $250, option B, and doesn't expire until 2021 the option is valued at $38.75 with a return of 403%. Depending on the clients appetite for risk and capital available would change which option I would recommenced. If the client has a low risk tolerance and would be uncomfortable and not be able to sleep because of losing all money invested I would avoid options. If the client has a slightly higher appetite for risk, I'd buy the option for $0.78 that expires earlier as the client would only lose $78 per option bundle as they come in lots of 100. If the client has additional capital and like higher risk for the reward I recommend buying the calls at $7.70. Most clients I would recommend this to as they have and an extra six months to increase in value and have a lower strike price of $250. The reason being if the stock price increases to $350 on 6/19/2020 the value of the options that expire 1/15/2021 is $105.64 compared to zero for the options that expire that day with a strike of 350. The return on the options expiring in 2021 would be 1272%. The only downside is the initial capital of $770 vs $78 for the earlier expiring options.