Snap Stock Tumbles with Unusual Call Option Activity, Even Though Its FCF Soared in Q4

Snap Inc. (SNAP) is down over 31% today and its call options show unusual activity. The culprit is management's lower revenue guidance and negative EBITDA forecasts. This is despite Snap producing huge free cash flow in Q4.

Despite reporting higher revenue by 5% YoY in Q4, Snap's stock is down over 31% from $17.45 yesterday's close to $11.17 in morning trading on Feb. 7. As a result, Barchart's Unusual Stock Options Activity Report shows that there is huge volume in some of its near-term call option contracts.

Why SNAP Stock is Down So Much Today

The main reason for the decline is that management said its revenue in Q1 would be in the range of $1,095 million to $1,135 million. This is significantly lower than the $1,361 million in sales for Q4 - i.e., down by 16.6% to 19.5%.

The stock market doesn't want to see lower sales. It is reacting violenting to this news. Here's why. 

SNAP said on page 4 of its earnings release that it expects to swing back to negative adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) in Q1 2024. They projected a range of negative $55 million to negative $95 million. 

That is after it made a positive $159 million in Q4 2023 adjusted EBITDA and positive free cash flow (FCF) of $111 million. The fear is that FCF will turn negative again in Q1, given the huge decline in sales that the company is forecasting.

SNAP  - Unusual Stock Options Activity Report - Barchart - Wed., Feb. 7, 2024

Unusual Call Options Activity

The Barchart Unusual Stock Options Activity Report shows that 46 times the normal volume of contracts have traded for the $12.00 strike price calls expiring on this Friday, Feb. 9. Moreover, 10 times the normal volume is trading for the calls at $12.00 expiring in 2 weeks on Feb. 23.

The latter trade looks very interesting. These calls are trading for 59 cents at the mid-price. This means that the buyer of these call options expects that the stock will expire above $12.59 in just over 2 weeks. Specifically, the premium involves a 91-cent increase or 7.79% over today's spot price of $11.68 (i.e., $12.59/$11.68).

The SNAP stock price may not even have to rise to $12.59 on or before Feb 23 for the buyers of these calls to make money. That is because the extrinsic value of the call options will likely rise along with any stock price increase. That could allow the buyers to sell for a profit. 

How To Play This

For example, assuming SNAP rebounds to $12.00, it's possible that the calls could rise to $1.00. This implies a potential 69% profit for the call buyers (i.e., $1.00/$0.59 -1 x 100).

But short sellers of these calls also can make money, although that is also risky. Buy buying SNAP today at $11.68 and then selling the Feb. 23 calls for 57 cents (i.e., on the bid side), they generate an immediate yield of 4.88% (i.e., $0.57/$11.68 purchase price).

This can also provide downside almost 5% protection against an unrealized loss should SNAP stock close below $11.68 on Feb. 23. That happens if the call option is not exercised due to being below the $12.00 strike price, but the stock price is below the purchase price).

The bottom line is that this violent move in the stock has attracted a large volume of options trades in SNAP stock. 

If you are bullish or expect a rebound in SNAP stock, buy the two-week expiry calls. If you think SNAP stock will likely stay at its present price or rise, buy the shares and sell short the calls. However, if you think the stock will keep falling sell short the calls. (This is a naked call strategy which is extremely risky and not recommended for most options traders - you need special clearance from your brokerage firm to do this).

The problem for most investors is that they do not have a clear line of sight to predict Snap Inc.'s forward-looking cash flow and fundamentals. That makes this type of trade a risky speculative one, not a typical value investment. As a result, most people will be careful in copying these options trades.

More Stock Market News from Barchart

On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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