By Greg Jensen
This year's highest profile social media IPOs have all sputtered. But, all are established, well-known companies whose prices are ridiculously depressed, down 50-85% from their launch. How low can they go? Is now the time to buy? A look at the options market might offer some clues.
One of the beauties of options is that they can be as complicated as you like. At their core, though, they are essentially simple. Calls (options to buy) are a leveraged bet on a stock rising, or, in the form of covered calls, can be a way of producing revenue from a stock you own. Puts (options to sell) are a leveraged bet on a stock falling, or can be used as a type of stop-loss, as insurance against a stock you own declining in value. It is the last of these, the insurance aspects of puts, that concerns us here. The cost to insure something depends on the degree of risk the insurer feels there is. Stock option puts can be seen in the same way. Let’s look at January puts for the three stocks.
*All prices are at the 08/21/2012 close.
While it is not possible to do an "apples to apples" comparison here, I have picked options that are as close as possible in terms of the distance from the current price. Without getting too deep into implied volatility or speaking Greek, the cost of a put tells us how likely the market believes a drop to that level is. In this case, a 16.5% drop in FB is seen as less likely than an approximately equal fall in ZNGA, or a greater decline in GPN. In other words, the options market is telling us that Facebook is the better buy of the three. It should be kept in mind that a Google (GOOG) put at around the same difference would cost around 1.4% of the stock price to buy. Groupon, Facebook and Zynga are all risky plays.
I believe there is an element to the Facebook situation that may make that a risk worth taking. Facebook, despite the tumbling stock price, the movie and the bad press around privacy, is intriguing. It has been a great story and has attracted some remarkable talent. Until now that talent has been used for product development, working to give the best user experience possible. The last few months have shown that the company’s pressing needs are in business development, so it is reasonable to assume that all of that innovative capacity and ability to attract talent is, right now, working on how to generate revenue. When Google was launched, many felt that the same problem existed; how on earth could you make much money from a free search engine? Doubt the nerds at your peril.
It would seem that FB has found at least a temporary, if weak, bottom below $19. My strategy would be to take a small position around here, with a view to averaging on a dip to around $18, should that occur, and bailing completely on a clean break of $16.
This trade is risky, for sure, and not for the faint of heart, but the options market indicates it is less risky than investing in the other two social media companies with recent IPOs. If the contrarian devil on your shoulder wins the argument, this may be the better option.
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