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Facebook Chief Executive Officer Mark Zuckerberg at the Allen & Co Media Conference in Sun Valley, Idaho July 12, 2012. (JIM URQUHART/REUTERS)
Facebook Chief Executive Officer Mark Zuckerberg at the Allen & Co Media Conference in Sun Valley, Idaho July 12, 2012. (JIM URQUHART/REUTERS)

Why markets fear a Facebook earnings surprise Add to ...

Investors in Facebook stock are bracing themselves for something wild.

After dropping about 25 per cent since its highly anticipated market debut in May, it is not surprising the market is bracing for big swings in Facebook Inc. shares after the social media company reports earnings for the first time as a public company.

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The options market is forecasting a 14 per cent move up or down in Facebook shares following the earnings, which are due after the bell on Thursday. That means options investors expect the stock to rise around as much as $32 by Friday – or fall to a low of about $24.

But this is not entirely Facebook’s fault. Investors tend to gird for big moves ahead of a company’s first results, particularly when it come to social media.

“Investors tend to be more nervous about these social media companies when it comes to their first earnings because there is nothing to compare them to. These firms need to show the market whether their business work or not,” said JJ Kinahan, chief derivatives strategist at TD Ameritrade.

An analysis by Credit Suisse showed derivatives markets overprice options ahead of the first earnings report from public companies in the sector, such as Zynga Inc. and Groupon Inc.

In eight out of 11 instances, the options market forecast larger swings than the actual post-earnings moves. The average implied move was 14.4 per cent – about what is expected in Facebook – when the actual post-earnings change has been only 8.5 per cent.

“Especially for Facebook, because it was such a highly anticipated stock that disappointed (the market), the demand for protection is up ahead of earnings,” said Kinahan.

There is no doubt that Facebook’s much-hyped IPO has been a disappointment. The stock closed down 1 percent at $28.45 on Tuesday, compared with $38 in its market debut on May 18 – the most anticipated tech IPO since Google Inc. went public in Aug, 2004.

The expected 14 per cent post-earnings move “implies there is significant uncertainty embedded in the derivatives market,” said Terry Wilson, equity derivatives strategist at Credit Suisse.

“While historical skew data is limited, the one-month skew is at its highest point, suggesting investor demand for protection,” Mr. Wilson added.

Skew measures the demand for downside put options versus upside call options.

Despite the steep decline in its share price, Facebook is still trading at around 70 times earnings, according to Thomson Reuters data. An analysis by Thomson Reuters StarMine puts the company’s intrinsic value at a modest $9.72 a share, or about one-third its current value, based on estimates of the company’s projected growth for the next decade.

Analysts, on average, expect revenue in the second quarter to grow 28 percent to $1.15-billion. During the same period a year ago, Facebook more than doubled its revenue.

With over 900 million users, Facebook is the world’s largest social networking company, challenging established Web companies for consumers’ online time and for advertising revenue.

As of Tuesday, 62,000 calls and 53,000 puts traded in Facebook stock, according to options analytics firm Trade Alert. Among the most actively traded contracts were the short-term options known as Weeklys that expire on Friday, a day after Facebook’s earnings report. These include the Weekly $25 and $26 strike puts and the Weekly $25 and $31 strike calls.

Option flow has been picking up over the past two weeks to average 120,000 contracts per day, making Facebook the sixth most actively traded option on an individual stock, according to Trade Alert.

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