How to Make a 50% Profit from a Dead Money Stock
Cocktail parties are an inevitable obligation for me as the spouse of a hard-working architect. Invariably, during introductions, the word gets out that I work for Investing Daily and I get barraged with stock questions.
On one particular occasion last week, someone asked me what I thought about Facebook (NSDQ: FB). I shook my head wearily and said that I thought the stock was “dead money.” He looked at me dejectedly, sensing from my body language that I wasn’t head-over-heels in love with his stock, but also quizzically. He replied: “So…what exactly do you mean by dead money?”
What Is a Dead-Money Stock?
His question took me aback because I use the term so frequently that I assume the term is self-explanatory, but upon further reflection I realized it really isn’t. I mean, my use of the unpleasant word “dead” could be construed to mean an ever-declining stock price on the way to bankruptcy.
Such a morbid meaning might accurately reflect the prospects of Sears Holdings (NSDQ: SHLD), but it certainly does not apply to a free-cash-flow generating machine like Facebook.
No, my use of the term “dead money” means lack of movement, as in no stock-price movement either up or down. Furthermore, it applies only in the short term, not in the intermediate-to-long term.
Now that the definition has been clarified, I have still begged the question: Why do I think that Facebook is dead money in the short term? After all, aren’t the company’s growth prospects in Europe and emerging markets huge and still in their infancy? Yes. And did I forget about Facebook’s very promising forays into live sports streaming, artificial intelligence, and augmented/virtual reality? No.
Facebook Is Going Nowhere Fast
Despite these things, I still feel that Facebook is dead money over the next six or so months because of residual investor ill-will surrounding the company’s disastrous second-quarter earnings report in late July that in a single day wiped out the most investor wealth in stock-market history.
As you may recall, Facebook dropped a bombshell on the investment community when it forecast a double whammy of decelerating revenue growth for the rest of 2018 along with higher expenses and lower profit margins. The revelation meant that Wall Street’s earnings estimates for next year were too high and the bad news was too much for investors, resulting in the stock tanking 19% in a single day, its largest one-day percentage drop ever.
Facebook stock has meandered lower since then and hasn’t been helped by the recent release of a congressional policy paper advocating widespread regulation of social networks.Despite the current bad news, this stock isn’t going anywhere. The company’s $3 billion to $4 billion in sustainable annual free cash flow and its strong balance sheet with zero debt arguably provides a solid price floor below the stock at right around technical support of $155. However, the uncertainty over new federal regulations, revenue growth, and profit margins also forms a price ceiling above the stock at around its earnings-related breakdown level of $210.
Believe you me, people who bought in at $210 prior to the July earnings report are desperate to break even and will start selling in droves if the stock ever gets back up to the $210 level. It will take many moons before all this “break-even” supply is worked off.
Getting back to my discussion at the cocktail party, after I explained to him what “dead money” meant, I refused to go further and volunteer any opinion on whether he should sell the stock. I didn’t know his cost basis, his investment horizon, or his tax situation, all of which are important data points prior to giving personalized investment advice.
Later that night, though, I got thinking about what I would tell someone who didn’t own the stock but who wanted to profit from Facebook’s long-term potential despite its near-term dead-money status.
Better Than Stock or a 6-Month CD
Buying the stock is not an option (pun to be made clear in a bit). Why shell out, say, $17,170 to buy 100 shares of Facebook right now when the stock is not expected to go anywhere for at least six months? The $17,170 you invest now could very likely be worth no more than – you guessed it – $17,170 in six months. With 6-month CD rates around 1.50%, that chunk of change could earn you more than $250 just sitting in the bank over that time span.
Although stuffing the money in the bank and waiting to buy Facebook in six months is one viable possibility, there is another way – a better way – to participate in Facebook RIGHT NOW despite the fact that the stock is likely to go nowhere. That way is through the use of stock options (earlier pun now made clear).
I’m not authorized to provide personalized investment advice, and I haven’t vetted Facebook through my proprietary seasonality calendar scanner in Options for Income, my options trading service that offers two option credit spread recommendations every single week of the year. Consequently, the forthcoming trade idea is for educational purposes only (paper trading with imaginary money would be okay).
Iron Condor Trade Example
That said, one could, for example, sell a Facebook January 155 put and simultaneously buy a Facebook January 145 put (i.e., creating a bullish put credit spread) for a net credit of 2.30 per share (i.e., $230 per option contract).
In conjunction with this bullish put spread, which wins if the stock closes above 155 at January 18th expiration, one could open a bearish call spread, which wins if the stock closes below $210 at January 18th expiration. Specifically, sell a Facebook January 210 call and simultaneously buy a Facebook January 220 call for a net credit of 1.05 per share (i.e., $105 per option contract).
Add the 2.30 credit from the put spread to the 1.05 credit from the call spread and you get a total credit of 3.35 for both credit spreads, which is known as an iron condor.
Risk of loss is limited to the difference between the strike prices minus the credits received, or $6.65 per share (10.00 spread width – 3.35 combined credit). If Facebook stays between $155 and $210 at January options expiration, one would earn a maximum potential profit of 50.4% (3.35/6.65).
Not a bad return for a stock that is going nowhere. I don’t know of any other investment strategy that generates a potential 50% rate of return on a stock that could go up or down by $15 or more and we don’t care which direction it ends up taking.
This Trade Is Likely to Work
According to my options analysis software, the probability that Facebook is below $155 at January expiration is only 32%, and the probability that Facebook is above $210 is only 13%. That means that the probability that Facebook will close in between 155 and 210 at January expiration is 55% (100% – 32% – 13%). In other words, it is more likely than not that this trade would achieve its maximum profit of 50.4%.
Sign me up!
With the odds in your favor, and assuming as I do that Facebook is dead money over the next six months, which sounds better: a 0% rate of return buying the stock, a 1.5% rate of return putting the money in a 6-month CD, or a 50% rate of return selling the January 145/155/210/220 iron condor?
I thought so.
Higher Return Means Higher Risk
Granted, the 1.5% in CD interest is risk-free, whereas the 50% potential profit on the put spread risks a loss of $665 per contract, but if one has the courage of her convictions and thinks Facebook will stay around current levels or go up a tad, then this investment “option” is for you.
The same options strategy can be used for other “dead money” tech stocks, such as Intel (NSDQ: INTC) and Netflix (NSDQ: NFLX), both of which will eventually benefit from the increased adoption of video streaming, but whose stocks are suffering from poor recent earnings reports.
So, the next time someone tells you that a stock is dead money, don’t be disappointed. Instead, turn dead money into gold through the use of stock options. Whoever said that a stock needs to go up for you to make money? While you may strike out once in a while, if you select options that put the odds in your favor, you’ll come out ahead in the long run and hit some home runs along the way.
How did I learn these money-making techniques? By standing shoulder-to-shoulder with the brilliant traders in the famous Chicago futures pit. I watched how they made millions and used their secrets to put together an investment system for my publication, Options for Income.
My system generates huge gains in up or down markets, good economic times or bad. It is, quite simply, the most sensible way I’ve ever found to generate large amounts of investment income, practically on demand.
Want to know more? Click here for a demonstration.