Meta Platforms Stock: Take Advantage Of The Trading Range (NASDAQ:FB)

Thesis

After stumbling by more than -30% in February when it announced disappointing results, Meta stock (NASDAQ:FB) has been consolidating in the $180 – $220 range. On the back of a hawkish Fed and substantially higher yields, Meta stock was helped by its robust Q1 earnings release which saw profits and daily user figures that came in ahead of expectations. We feel the era of breakneck growth for Meta is behind us, and the higher interest rate environment is not going to help drive investor speculation in the stock as we have seen in the past years through the now infamous gamma squeezes of 2021. We now expect Meta to consolidate and be range-bound for the rest of 2022, with the weakness induced by higher yields offset by solid fundamental results from the company. Given the significant moves in the stock this year the option chain for Meta now exhibits a very high implied volatility, which in turn translates to rich option premiums. A good way to monetize our range bound view for the stock is to engage in what is a called a “short strangle” strategy, or namely selling concurrently an out of the money put with a lower strike than spot and an out of the money call with a strike higher than the spot level. The proposed trade is in essence an options based expression of a range bound view, and if at the expiry date the stock stays within the $175 – $250 range an investor can pocket an annualized yield of 26%.

What is a “short strangle”

Despite its very bombastic name a “short strangle” trade is not overly complex. It involves selling two out of the money options on the underlying stock.

Leg 1: Selling an out of the money put with a lower strike than the spot level

• basically an investor underwrites the potential purchase of the stock at a much lower strike level in exchange for a premium
• the closer the put strike to the spot level the higher the premium

Leg 2: Selling an out of the money call with a higher strike than the spot level

• here an investor believes the stock price will not reach the higher price at expiry date
• a premium is received in exchange for the written call option

By selling two options, an investor significantly increases the income that would have been achieved from selling a put or a call alone. On the downside the risk is similar to owning the stock at a lower strike level, while on the upside the risk is technically unlimited if you think Meta is set to appreciate significantly.

What is the trade

Specifically our proposed trade is:

An investor can concurrently sell a January 20, 2023 put with a $175 strike, while concurrently selling a call with a $250 strike for the same maturity. The net premium received from this trade amounts to $3,363 for 1 contract, which represents a 19% portion of the maximum cash out on the put side, or better framed a 26% annualized yield on the trade if both options expire worthless.

A visual guide for the trade payoff is below:

The green line represents the profit line in the above graph, and as long as the Meta stock price upon expiry stays bound by $175 – $250, an investor realizes the full profit from the trade. As the stock price goes below $175 for example the profit level is decreased and the trade only starts incurring a loss if Meta goes below $142/share. Why the lower breakeven level? That is because the premium is factored in when calculating the breakeven level.

Basically on the downside, in the worst case scenario, an investor ends up buying the stock at a $142/share breakeven level.

Potential Outcomes for the trade:

Scenario 1

• The Meta stock is within the $175 – $250 range in January 2023
• Both options expire worthless
• The investor pockets the premium, realizing an annualized yield of 26%

Scenario 2

• The Meta stock falls below the $175 strike upon expiry
• The call expires worthless but the put is triggered
• Given the net premium (call premium + put premium of 33.63 per contract) the investor has a $142/share breakeven level
• The investor gets assigned the stock

Scenario 3

• The Meta stock goes above $250/share
• The put expires worthless but the call is triggered
• Basically the investor ends up being short Meta at a breakeven price of $283/share

From a risk perspective the most concerning for an investor is Scenario 3, but then again the breakeven level on a stock appreciation scenario is approximately 32% higher than the current spot level, and given the current Fed tightening environment it is highly unlikely that Meta is going to rocket back to its 2021 levels in the near future.

Conclusion

Technology shares have experienced a significant drawdown in 2022 on the back of higher interest rates and a hawkish Fed. The period of ever increasing price levels for the Meta stock as seen in 2021 is behind us. After suffering a significant sell-off in February on the back of disappointing results, Meta is now settling in a range, helped by better than expected fundamental results. We do not see the shares skyrocketing back to their 2021 levels any time soon, and we feel they are going to be range-bound. A good way to monetize this range view and extract a very robust 26% annualized yield is via the trade described above, where an investor concurrently sells an out-of-the-money low strike put and an out-of-the-money high strike call.