Want to Profit From Facebook's Coming Earnings Report? Try This Trad... https://www.thestreet.com/story/13533235/1/want-to-profit-from-facebo...

Even if you don't have a clue about whether Facebook (FB) will meet or
miss expectations when it reports earnings, you can use calendar spreads
to earn a juicy profit.

Terry Allen Apr 19, 2016 11:39 AM EDT

No matter what happens with Facebook's (FB) coming earnings report, you can profit by
using stock options.

Facebook plans to report results on April 27, and this tech giant is capable of delivering
big surprises that can have a significant impact on its stock price. Look at its last earnings
report, on Jan. 27, for example. Adjusted earnings per share came in at 79 cents, blowing
away the average estimate from analysts of 50 cents. Shares rocketed nearly $15 higher

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in the following session and drifted even higher in the next week or two.

A couple of weeks ago, analysts at Deutsche Bank warned that the companies first-
quarter results wouldn't be so strong, and the stock sold off sharply. Still, shares are up
about 4.8% so far this year.

There is a lot of uncertainty surrounding the coming earnings announcement, and no one
really knows what the stock will do following the news. Will the market focus on how well
Facebook is monetizing its incredible traffic, its earnings growth, its sales, or its guidance?
Maybe inroads in China or early sales of its Oculus Rift VR headset or the prospects for
Messenger chatbots will be the hot button for investors. Who knows?

Facebook is a holding in Jim Cramer's Action Alerts PLUS Charitable Trust Portfolio. See
how Cramer rates the stock here. Want to be alerted before Cramer buys or sells FB?
Learn more now.

There are some things that we do know, however:

1. The implied volatility of the Facebook options that expire on April 29 (just two days after
the planned earnings announcement) is 52, a staggeringly high number. Remember
that implied volatility, or IV, is an important determinant of option prices: A high IV
means that option prices are quite expensive and a low IV means that option prices are
relatively cheap.

2. The implied volatility of the options that expire on June 17 is much lower, at 35. These
options expire 49 days later than the April 29 options.

3. According to the CBOE option calculator, an at-the-money 110 option with 49 days of
remaining life will be worth $5.11 ($511 per contract) if its implied volatility is 32 (the
current implied volatility of the April 22 options, which expire before the earnings
announcement).

You can take advantage of the wide disparity in the implied volatility of the April 29 and
June 17 options by executing an options trade known as a calendar spread. In a calendar
spread, you buy and sell options contracts on the same underlying stock, but your
purchases and sales are on contracts with different expiration dates.

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READ MORE: The Rise of Chat Bots: Is Conversational Commerce the New Email?
This article is commentary by an independent contributor. At the time of publication, the author held
positions in FB, JNJ, ABBV, and SBUX.

Right now, calendar spreads consisting of selling April 29 Facebook options contracts and buying
June 17 contracts are a screaming buy. These calendar spreads cost no more than $1.60 (or $160
per contract, not including transaction fees). Depending on the strike price, many calendar spreads
will cost even less.

The bottom line here is that if you select a strike price that is at the money when the April options
expire, a calendar spread that costs $160 or less right now would be worth more than three times that
amount on April 29.

We have had a lot of success trading option spreads in advance of earnings announcements. Over
the past three weeks, Terry's Tips blog has showed how to leg into pre-announcement calendar
spreads on Starbucks, Johnson & Johnson and Abbvie at a credit. Anyone who followed the
directions now owns calendar spreads that are guaranteed to turn profits once the short options
expire shortly after the companies release earnings. The magnitude of the profits will depend on how
close to the strike price the stock price ends up (the closer, the greater the profit, of course).

Starbucks is a holding in Jim Cramer's Action Alerts PLUS Charitable Trust Portfolio. See how
Cramer rates the stock here. Want to be alerted before Cramer buys or sells SBUX? Learn more
now.

Over the past few quarters, Facebook's stock price has fluctuated an average of a little more than 5%
after earnings. Implied volatility of the post-announcement options suggests the market thinks the
fluctuation might be greater this time around. With this in mind, we'll try to increase our chances of
ending up with an at-the-money calendar spread after the earnings announcement. We plan to buy
spreads at three different strikes. Following are the four Facebook calendar spreads I am placing in
my personal account.

1. Buy to open 1 FB Jun-16 105 put (FB160617P105) and

sell to open 1 FB Apr5-16 105 put (FB160429P105) for a debit of $1.40

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Want to Profit From Facebook's Coming Earnings Report? Try This Trad... https://www.thestreet.com/story/13533235/1/want-to-profit-from-facebo...

2. Buy to open 1 FB Jun-16 110 put (FB160617P110) and

sell to open 1 FB Apr5-16 110 put (FB160429P110) for a debit of $1.45

3. Buy to open 1 FB Jun-16 110 call (FB160617C110) and

sell to open 1 FB Apr5-16 110 call (FB160429C110) for a debit of $1.60

4. Buy to open 1 FB Jun-16 115 call (FB160617C115) and

sell to open 1 FB Apr5-16 115 call (FB160429C115) for a debit of $1.55

These spread prices were available when the stock was trading at $109.60 when the market closed
last Friday. These prices are slightly higher than the midpoint between the bid and ask quotes for
each spread (you might be able to get them at the midpoint, and you should try that price before
going higher).

You'll note that the trades above double up on the spreads at the current at-the-money price ($110),
using put options for one of the calendar spreads and call options for the other. This assures that at
least one of those spreads will be out of the money when it's closed out. (You can usually get better
executions when selling calendar spreads that are out of the money.)

If you buy one of each of those four calendar spreads, you will shell out $600 plus about $10 in
commissions. The risk profile graph below shows the possible loss or gain at the various possible
ending prices when the April options expire on April 29. This graph assumes that implied volatility for
the June options will fall to 32 from its current level of 35. As noted earlier, the April options that
expire a week before the earnings announcement have an implied volatility of 32, making that
assumption seem appropriate.

Risk Profile Graph for Four Facebook Calendar Spreads on April 29, 2016

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The $610 investment could make more than $800 if Facebook ends up close to $110 after the
announcement. The graph shows that the break-even range extends from about $101 to $121. This
works out to about 10% in either direction, almost double the average price change after the last few
earnings announcements, but just about the same change as last quarter when the company
reported particularly surprising numbers.

The long sides of the calendar spreads will always have a greater value than the short sides, and
when the spread costs $1.60 or less, that is not a lot to expect. Based on the CBOE option calculator,
if Facebook stock is $5 above or below the strike price, the 49-day option will be worth $2.90 more
than the expiring option, and if Facebook stock is $10 above or below the strike price, the calendar
should be worth about $1.45, or very close to what you paid for it. If the stock price is more than $11
above or below the strike price, you will probably incur a loss on that spread.

You don't necessarily have to close out (sell) your calendar spread on April 29. We happen to like
owning calendar spreads at strike prices just above and below the current stock price. We will
probably sell the spread which is furthest away from the stock price on that day and retain the June
options, selling new options that expire one or two weeks later than April 29. An at-the-money option
with one week of remaining life should fetch about $1.90 (assuming an implied volatility of 32), and
we will have seven opportunities to sell one-week options against those June puts or calls.

One should feel comfortable owning these four calendar spreads at what are attractive prices. If the
stock fluctuates less than $10 or $11 in either direction, we should make immediate gains on April 29
(as much as doubling the investment), and at the very worst, we will own options that we might sell
weekly options against over the subsequent seven weeks. In any event, we expect to be able to at
least break even no matter where the stock price might end up.

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