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How You Could Profit Alongside Facebook Inc.

By Joe Tenebruso - Dec 30, 2014 at 1:19PM

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This put strategy trades some upside in order to gain some downside protection on Facebook stock.

At Tier 1 Investments, a Motley Fool Real-Money Portfolio, I seek out businesses with a strong balance of current competitive dominance and future growth potential. Among all the companies I follow, Facebook (META 1.70%) has one of the best combinations of a powerful, competitive moat and massive long-term growth opportunities. So much so, that I will be making Facebook one of the largest positions in Tier 1.

Facebook is a classic Rule Breaker that is fundamentally changing the way people interact and connect with each other. Impressively, it also displays many of the characteristics of a Rule Maker, as its network of more than 1.3 billion monthly active users dwarfs that of its competitors, and has made gaining access to its platform a requirement for advertisers worldwide.

Source: Statista.com

But rather than near its peak, as some might suggest, I believe Facebook is still early in its growth cycle. Even today, with a market capitalization of more $220 billion, the social media titan currently commands only about 2% of the global advertising industry -- a massive market that is expected to surpass $600 billion in 2015.
 

Source: Statista.com

And the trend is certainly working in Facebook's favor, as more dollars migrate from traditional media to digital platforms, where people around the globe are spending more and more of their time in an increasingly mobile world.
 

Source: emarketer.com 

This, in turn, has led to strong and rising cash flow generation for Facebook -- a trend I expect to continue.
 

Source: YCHARTS

Tier 1's strategy
I want to increase Tier 1's ability to profit alongside Facebook, but I want to do so in a more conservative manner than simply buying shares. That's because while I'm excited about Facebook's long-term potential, the next 12 months could be somewhat volatile. Management has stated that they expect 2015 to be "a significant investment year" with expenses "likely to increase 55%-75% compared to the full year 2014." Although that outlook is now likely to be at least partially priced into Facebook's share price, should the company's expenses come in at the high side of that range, Facebook's stock could underperform in 2015. With Facebook's shares currently trading near all-time highs -- as well as the market as a whole -- I'm willing to trade some upside in order to gain some downside protection.

To do so, I will be selling puts on Facebook. With this option strategy, I will be paid a premium to enter a contract to buy 100 shares of Facebook at a specified time and price. Specifically, I will be selling the Facebook January 2016 $80 puts, currently trading at about $10 per share. If Facebook is trading at or above $80 on the Jan. 15, 2016, expiration date, the puts will expire worthless. And the $1,000 I receive in premium ($10 per share times 100 shares) will amount to a 12.5% gain on the $8,000 at risk ($80 per share times 100 shares).

If Facebook is trading below $80, I will be obligated to purchase shares at an adjusted price of $70 ($80 strike price minus the $10 per share in premium), or about 12.5% lower than today's $80.02 price. I think it's also important to note that I would be buying Facebook in January 2016, after the company will have had time to grow its earnings and cash flow significantly. So, in effect, I would be buying shares of the social media king at a better valuation than is possible by simply buying shares today. And, importantly, I'd be very happy to purchase Facebook's shares at that adjusted $70 price.

Finally, between the time I sell the puts and the expiration date, I will have the option of buying back my puts or rolling them to other strike prices and/or expiration dates. And so, with this put writing strategy, there will be many ways to earn a profit.
 
 

Joe Tenebruso is portfolio manager of Tier 1 Investments, a Motley Fool Real-Money Portfolio. You can connect with him on Twitter @Tier1Investor. Joe has no position in any stocks mentioned.

The Motley Fool recommends Facebook, Google (A shares), Google (C shares), and Twitter. The Motley Fool owns shares of Facebook, Google (A shares), Google (C shares), and Twitter. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Meta Platforms, Inc. Stock Quote
Meta Platforms, Inc.
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Alphabet Inc. Stock Quote
Alphabet Inc.
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Twitter, Inc. Stock Quote
Twitter, Inc.
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Alphabet Inc. Stock Quote
Alphabet Inc.
GOOG
$122.65 (2.36%) $2.83

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