Facebook IPO: Options coming soon!

TradeKing’s Brian Overby outlines some points to remember if you're interested in trading option contracts when they are available in facebook after the Initial Public Offering (IPO).

Details of IPO

If all goes as planned, Facebook will go public on May 18th.  The IPO price is estimated to be around $34 to $38 a share which would value the company at more than $103 billion according to this Wall Street Journal article. Facebook will determine its final price and file its last IPO documents with the Securities and Exchange Commission Thursday evening, one night before it’s first day of public trading on Friday. When it goes public, Facebook will trade on the Nasdaq under the symbol "FB."

Buying the stock once public

Trading a stock that has just become available on the public market is not for the faint of heart and this isn’t just any stock - it’s Facebook. While the offering price of the IPO may give some indication, the price once trading on the secondary market may be much different than the price of the IPO.  The exchange will try to determine an opening price based on all the pending orders in the queue. The bottom line, expect the stock’s price to be very volatile in the opening hours of trading and remember volatility means both up and down price swings. Because of these potential wild swings TradeKing will not accept market orders on Facebook prior to the open.  I must emphasize that all orders entered PRIOR to the open must have a limit price. A “limit” order will only be filled if someone is willing to trade at that price. In other words, if filled, it will have to be at that limit price or better, but there is no guarantee it will/can be filled. This is much different than a “market” order which guarantees the fill, but what is not guaranteed is the execution price. The most important thing to understand is that all limit orders are considered "or better" trades.  If the trade can be filled at a better price when the trade gets to the exchange - it will be. For example, if you place an order to buy it at 50 and the price available when your order is presented to the public market is 41 that is where the trade should be executed. (Note: different brokers will have different rules regarding opening transactions in IPO so please check with your broker prior to trading.)

Summary:  If placing a Facebook stock order at TradeKing

1) Orders can only be placed after the close Thursday, May 17th (after  4:02 pm ET). These orders will remain "Pending" until reviewed Friday morning, when the orders can be opened. A pending order CAN still be rejected.
2) All orders must be entered with a limit price.
3) The account must have cleared funds to be able to pay for all the shares at the stated limit price. FB will not be marginable to start and may remain on the 100% cash requirement for some time after the launch.
4) Also, the “limit order only” restriction may continue for a few days after the initial opening trade.

Options on Facebook?

Options WILL NOT begin trading on FB on day one with stock. The anticipated date for the listing of Facebook option contracts is May 29th, according to a press release put out by the International Securities Exchange (ISE).

Trading both puts and calls on FB will be tricky to start. There will most likely be wide bid/ask spreads on the option contracts until the market makers have some price discovery. To expand on that concept, the hardest job of the market makers in IPO option contracts is to get the implied volatility (IV) number correct for each expiration available. This is because there is not much historical stock price data to go off of. So this normally means the difference between the asking price for an option may be artificially higher than the bidding price. This usually occurs to help compensate for the risk of getting this IV number wrong. This can increase the overall cost to the traders that want to invest in these options.

Also, outright buyers of puts and calls will want to be weary of a possible implied volatility crunch on the options after the first week of trading.  Market makers will most likely spike up implied volatility in general to begin with, and you can get burned if the stock settles down quickly thereafter. You should also be aware that buying put and call options can result in the loss of 100% of your investment, should FB go against you. Learn more about long puts and long calls here. Trading options on highly publicized IPO stocks is tempting, but it is very important to understand that there are many forces in play with the pricing and trading of the option contracts besides the volatile movement of the stock price.  You’ve been warned!

Learning from Groupon’s IPO

In an article posted November 4th on CNN Money it announced Groupon’s Initial Public Offering  and the projected price of $20 per share. The high water mark of the stock was $31.14 and is now trading as of this writing around the $12.50 mark. Many expected the volatility in Groupon stock price to settle down by now and it just hasn’t happened. Another important note is that GRPN has been in a "hard to borrow" state for most of its life because of all of the short sellers. If a stock remains hard to borrow due to high levels of short selling, it usually inflates put prices vs that of calls. Now past performance does not guarantee a future result and Facebook is definitely a much larger and more talked IPO than Groupon.

Bottom line is with IPOs you never know what may happen to the stock price and that is even more true when it comes to option contract prices.

Regards,
Brian Overby
TradeKing's Options Guy
www.tradeking.com

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options available at http://www.tradeking.com/ODD.

Brian Overby currently holds no positions in any mentioned securities.

Online trading has inherent risk due to system response and access times that may vary due to market conditions, system performance, and other factors. An investor should understand these and additional risks before trading.

While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.

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