The major meltdown in Facebook (FB) stock grabbed headlines [Thursday], as FB stock lost $41.24 (18.96%).

The earnings rout was courtesy of slowing user growth on both a monthly and daily basis.

Considering FB stock’s major rally in front of earnings, a pullback certainly was not unexpected.

A pullback of this magnitude, however, was entirely unexpected and overdone. Look for FB stock to find its footing near current levels over the coming weeks.

In a previous post on FB stock, I had a decidedly bearish view. I made the case for shorting Facebook stock above $200. The bear case was based on extremely rich valuations and overbought technicals. [Thursday’s] bloodbath in FB stock rectified both of my concerns and then some. My view has subsequently changed to a decidedly more bullish one … because stock price does matter.

Facebook valuations have come down to much more realistic levels following the 19% drop. The current price-earnings ratio (P/E), which previously was approaching 35, now stands at a much more amenable 27.3.

Other traditional valuation metrics, such as price-sales and price-cash-flow, have also tempered dramatically as well. While user growth did slow, it is important to remember that earnings did actually beat consensus at $1.74 per shares versus estimates of $1.72.

From a technical perspective, shares of Facebook went from overbought to oversold in just a single day!

Nine-day RSI is now below 25, marking levels that have signified significant lows in the past. There is major support at the $171 area, which coincided with the gap higher following the privacy issues fiasco in late March. FB stock did break the 200-day moving average at $181.56, which now will likely be a short-term upside target for the stock.

Implied volatility (IV) in FB options remains elevated even following earnings due the massive drop in the stock. Current IV percentile stands at 65%, meaning option prices are still comparatively rich, favoring option selling strategies. So to position to be a buyer of Facebook on further weakness, an out of the money put credit spread makes probabilistic sense.

Trade Idea for FB Stock

Buy FB Sept $155 puts and sell FB Sept $160 puts for a 70 cents net credit

Maximum gain on the trade is $70 per spread with maximum risk of $430 per spread. Return in risk is 16.27%. The short $160 strike is well below the $171 support level and provides a 10% downside cushion to the $176.26 closing price of FB stock.

Tim

Tim may hold some of the aforementioned securities in one or more of his newsletters.

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Source: Investor Place