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Facebook Stock Options: Proceed with Caution

By , Money Morning •

As Facebook (Nasdaq: FB) continues to try to save face after its IPO flop and the myriad mess ups that followed, investors now have a new way to trade the most talked about stock this year.

Options on the social networking giant started trading today (Tuesday) on the NYSE Amex. BATS Options Exchange will list options starting Wednesday.

So far, staying with the Facebook stock theme, investor interest has been high.

As trading began this morning, volume for puts exceeded calls by 1.29-to-1, according to data compiled by Bloomberg News. More than 62,000 puts, giving the right to sell, traded by 11 a.m. June $30 puts were the most active contracts, with volume at 10,974, followed by June $34 calls and June $32 calls.

"Facebook options, like the stock in its debut, post impressive first day volume so far," explained the Dow Jones' Kaitlyn Kiernan to The Wall Street Journal. "Facebook looks poised to become one of the most-traded corporate options today, with a total of 17,232 options - 7,476 puts and 9,756 calls traded in the session's first 15 minutes."

Facebook Stock Options: More Risk than Reward?

Given that Facebook stock sank in the days since its initial public offering, Barron's reports that the options are expected to be too pricey to buy and too discounted to sell.

A senior executive at a major Wall Street firm told Barron's, "On Day One you will be able to drive a truck through the spreads. Don't buy options until she settles in."

The wide difference between the bid and the ask prices signal continued investor insecurity about Facebook's stock price and the company's true worth. Wide spreads are more profitable for dealers, while less attractive and less beneficial to investors.

The insecurity stems from the rocky road Facebook has followed since its storied debut.

Facebook's first day of trading was met with technological glitches and condemnation that it overestimated demand and sold too many shares.

A week after its IPO, the stock was changing hands at $31.47, down 17.2%. Class action law suits were filed last week from scores of investors who felt mislead about the IPO and Facebook's real company value.

But there's more than just the Facebook stock price that will determine the prices of puts and calls, and their spreads.

What has the most crucial influence in determining the price of an option is implied volatility, which is expected to be extraordinarily high and elastic as Facebook stock options start trading.

Barron's reported dealers will likely set implied volatility at 50% to 55%. That was based on other social media stocks, such as the professional networking leader LinkedIn (NYSE: LNKD), leading gaming stock Zynga (Nasdaq: ZNGA), popular internet radio company Pandora Media (NYSE: P) and Internet search behemoth Google (Nasdaq: GOOG).

But implied volatility for the July $25 puts was 65%, meaning the options are priced as if the stock will move about 4% up or down before expiration.

"From LinkedIn to Zynga to Pandora and now Facebook, the evidence is clear that the one certainty for investors is share prices of social media companies are volatile and will likely remain so," Garerth Feighery of MarketTamer.com told Reuters.

Option Risk

Facebook's options present opportunities to market participants who want to hedge shares, take advantage of volatility, and would like to short shares but can't borrow stock. Nevertheless, risks abound.

Aggressive investors will find the ambiguity around Facebook very attractive. Many will pounce on selling Facebook's high-priced puts wagering that implied volatility will eventually rest at a lower price as dealers get a better hand on the underlying options and stock's trading patterns.

"The real issue, like everything else in the market, is about value. And with Facebook, we simply don't know what their true earnings power is at this moment," Jeff McAllister, vice president of education at Optionsanimal.com, told Reuters. "The first day of trading is going to be completely speculative to begin with and it will be aggressive - flooded with day-traders trying to make a quick turn in the market. But institutions are expected to be on the sidelines waiting patiently as disciplined traders do."

Prior to the IPO, investors had a floor on what to expect regarding the share price of Facebook. Yet, in the options market there is no clear signal of what the demand will be, or the price.

Expect trading to be very active and fickle in Facebook options especially during the first couple of days.

"We could easily see a couple hundred thousand contracts trading for Facebook options simply because the underlying share volume is so strong and there is so much hype about the IPO," Trade Alert President Henry Schwartz told Reuters.

The options are coming out so quickly because of the gigantic retail demand.

"It's a cocktail party stock and probably will attract a lot of participation from retail traders," Steve Place, a founder of options analytics firm Investing With Options, told Reuters.

Facebook stock had slipped almost 9% by 1:30 p.m. EDT Tuesday to $29.17.

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