Liking or hating social media

Sun Jul 29, 2012 1:23pm EDT

Monitors show the value of the Facebook, Inc. stock during morning trading at the NASDAQ Marketsite in New York June 4, 2012. REUTERS/Eric Thayer

Monitors show the value of the Facebook, Inc. stock during morning trading at the NASDAQ Marketsite in New York June 4, 2012.

Credit: Reuters/Eric Thayer

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(Reuters) - Shares of social media giant Facebook Inc, which bungled its initial public offering in May, have been under the gun ever since, hitting a nadir on Friday after dismal inaugural results.

While the earnings have cast a chill over Facebook shares, which have already lost 38 percent of their value from their $38 debut price, not every social media stock has been tarred with the same brush. Facebook shares on Friday dropped 11.7 percent to $23.71 while LinkedIn Corp shares rose 2.6 percent to $103.42.

Besides Facebook, online game company Zynga Inc, LinkedIn and real estate website Zillow Inc went public in the last year. Many of the shares have been hit hard, and their struggles have raised concerns about their outlook.

"With all the headwinds that Facebook faces, a high valuation and an oversupply of stock after the August 16 lock-up, I would not touch any of these social media stocks," said Michael Khouw, managing director and head of equity derivatives at CRT Capital Group, an institutional broker-dealer in Stamford, Connecticut.

But some analysts are not ready to condemn the entire sector.

"Of the stocks in the social media space, it looks like there are two paths. Facebook, Groupon and Zynga have been big losers in the past few months, while LinkedIn and Zillow have held their value," said Brent Archer, options analyst at options research firm InvestorsObserver.com, in Charlottesville, Virginia.

FACEBOOK OPPORTUNITY

Some investors believe Facebook poses an opportunity, particularly in the options market, where the amount of capital required to speculate on a stock's direction and volatility is lower than buying or selling shares outright.

"Social media is certainly here to stay, but it appears so is volatility when it comes to their stock prices," said Dan Passarelli, chief executive officer at options education firm MarketTaker.com in Chicago.

A popular covered call trade or the sale of puts would be two bullish strategies for investors to implement because they would be both profitable to a certain extent if Facebook shares move higher.

Michael Schwartz, chief options strategist at Oppenheimer Co & Inc, recommends a covered call strategy on Facebook, a trade which involves selling call options against a current long position in the shares. The trade provides downside protection and limited upside participation.

Based on a stock price of around $24.31, the March $25 strike call -- giving the buyer the right to buy the stock at $25 by mid-March 2013 -- can be sold for a premium of $3.60. The trade would start to make money if shares rise above $25 by March expiration. The risk is if the stock trades below $20.71 by expiration.

"The share price decline in the stock has given us an opportunity to implement this strategy," Schwartz said. Oppenheimer has recently initiated coverage of Facebook with an "outperform" rating on the shares, with a 12-to-18 month price target of $41 a share.

Another strategy for an investor would be to sell put options as a way to potentially own the stock at a discount to where it is currently trading. Put options convey the right to sell shares at a fixed price by a certain date.

"While many may view this as the final death knell for a social media stock bubble that never really inflated, it could also be an opportunity," said Steve Place, a founder of options analytics firm investingwithoptions.com in Mobile, Alabama.

"If an investor would like to own Facebook stock at a better basis, using a cash-secured put sale would be advantageous after this big earnings drop," Place said.

For example, Place said an investor could sell the September $21 strike put for $1.10. This gives the investor the obligation to own Facebook stock at $21, and they receive cash upfront or a credit of $1.10 for assuming that risk. The risk is if Facebook stock continues lower, then the position behaves very similar to just owning the stock, Place said.

If assigned, the investor would own Facebook shares at a basis of $19.90, which is an even steeper discount from the current price. If Facebook stays above $21 by September expiration, then they receive the full credit without assignment, which would be a return of 5.5 percent.

SEARCHING FOR STOCKS

InvestorsObserver's Archer said there is a perception in the markets that LinkedIn and Zillow should be better able to monetize their business than other social media companies.

LinkedIn is due to report quarterly earnings on August 2 after the close, so options premiums are high right now, Archer said.

"Our analysts like the LinkedIn September $85-$80 bull-put credit spread for an 80-cent credit per share," Archer said. "That trade will make a 19 percent simple return as long as LinkedIn shares are above $85 at September expiration."

A bull-put credit spread involves selling the $85 strike put and simultaneously purchasing the lower strike $80 put. This strategy is a moderately bullish position with limited risk and provides protection for the investor, Archer said.

LinkedIn shares would have to fall by more than 16 percent in the next two months to cause a problem, Archer said. If the shares head higher from Friday's price, stay flat or even fall a little, this trade will be successful.

"The entire social media space may seem like a disaster, but it's perhaps that public markets have yet to see the right stocks," Place said.

(Reporting by Doris Frankel in Chicago; Editing by David Gaffen, Walden Siew and Matthew Lewis)

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