Facebook Inc (NASDAQ:FB) stock is slumping today, likely part of a broader market decline triggered by Brexit which has sent major stock indices around the world and other heavyweights like Apple tumbling. Well-known short-seller Andrew Left of Citron Research said earlier this month that he’s shorting FB stock, taking up the contrarian view, but now there’s another call to short it, this time from a stock chart technician.
Bearish flag pattern emerging on Facebook stock chart
InvestorPlace contributor Chris Tyler highlighted a technical pattern that’s forming on the Facebook Inc (NASDAQ:FB) stock daily chart and may indicate that we could see a round of profit-taking very soon. He observed a “bearish flag consolidation with the 50-day simple moving average acting as pattern resistance.” He said that in the event that investors start to pressure the social network, the first support area is in the $106.50 to $109 per share range. He said an earnings gap fill and Facebook’s 200-day simply moving average are backing this range.
However, he sees room for downside due to even “modest” profit-taking within the uptrend of Facebook stock compared to any upside risk short-sellers might face. As a result, he suggests the “bearish butterfly strategy” for investors who believe FB stock might be headed for a nosedive soon.
Butterfly options strategy for FB stock
Instead of shorting the stock outright with the resulting high gap risk, Tyler suggests a long August $115/ $105/ $95 put butterfly options strategy. This spread on Facebook stock is priced at $2.05 with a $114.45 per share price on the stock currently. The profit zone on the spread expires between $97.05 and $112.95. If Facebook Inc (NASDAQ:FB) stock ends up at $105 upon expiration, the spread would bring an investor the highest possible return at nearly 400% or $7.95.
He adds, however, that investors shouldn’t just buy the option and forget about it even though the risk/ reward profile looks attractive. He suggests a reevaluation of the position if profits or losses reach 50% of the first debit.
Problems with Facebook’s revenue model?
So why might Facebook Inc (NASDAQ:FB) stock decline, warranting a bearish options strategy? Tyler alluded to a post by another InvestorPlace contributor who said that there are inherent problems with Facebook’s revenue model because it is basically a “digital billboard,” which means that at some point, economic cycles will likely impact it as spending on digital advertising declines. For now though, it seems the sky’s the limit for the social network, however, and a recent study on large-screen smartphone users suggests that Facebook’s ad revenue won’t face a downturn anytime soon.
Morgan Stanley analyst Brian Nowak and team released a report on June 22 covering data on large-screen smartphones and how it pertains to Facebook and other big-name Internet firms. Their AlphaWise data suggests that smartphones with screens of at least 5.5 inches in size are expected to grow to 30% of the global install base, excluding China, by 2018, which is more than double their 12% share last year.
The data also suggests that this shift is good for Facebook because social engagement on larger smartphones is higher by up to 9%, especially iOS users. Of course higher engagement means higher monetization, so they’re raising their 2017 ad revenue estimate for Facebook 2%. This survey seems to suggest that short-sellers who are backing on a decline in FB stock due to the cyclical nature of advertising revenue may be waiting a long time for returns. However, if Tyler is right about the bearish chart pattern emerging and what it means for the stock in the near term — and the Brexit vote is certainly helping things along — then there could be a short time of profit-taking that short-sellers could benefit from soon.
One additional question is whether shareholders will put up any resistance to the upcoming stock split and whether there will be a mass exodus because of that split rather than profit-taking. Of course Google has had a structure which gives shareholders little or no say in how things are run and still does very well, so it seems likely that Facebook will still find plenty of investors to support it.
FB stock plunged to open the day at $111.01 per share before bouncing. As of this writing, the stock is down 1.03% at $112.86.