Meta shares look 'iffy' into earnings. How to trade it

Meta heads into earnings Wednesday after the bell with the fundamentals case largely intact.

Ad-pricing improvements and sharper targeting continue to drive roughly 30% year over year top-line growth — a number that commands respect at this scale. The options market implies a substantial 7.5% move by the end of the week. That's a lot for a company this big, but it's justified given the big moves Meta has seen following earnings recently (the stock moved more than 10% following earnings in three of the last four quarters).

We've seen some big call buying lately. The June in-the-money 620 strike calls, for example, saw substantial opening buyers Monday. So did the May $675 calls, which cost substantially less and are more focused specifically on earnings.

## The trade

Personally, I wouldn't buy the stock or either of those two calls; instead, I would look to trade a spread — specifically, the 625/680/750 call spread risk reversal — selling the 625 puts and 750 calls to help finance the purchase of the 680-strike at-the-money calls.

Here's why.

First, technically, despite the solid fundamental backdrop, the technicals are a bit more iffy. Meta is lingering around the 150-day moving average, and, having recently fallen below it, this reversion may be a head fake. Other technical signals, such as the commodity channel index and Bollinger bands, also indicate that the stock's position is precarious.

Second, a quick review of the stock's performance around earnings shows that buying the stock into the print is a bit of a coin toss. Was the stock higher two weeks after earnings more often than not? Yes, but just barely. The histogram below shows that stock buyers would have had an average return of 0.92% by buying META into the earnings print and holding for two weeks thereafter. That works out to an annualized rate of return of almost 16.8%. That's not terrible, but given the volatility of returns, not necessarily the risk/reward ratio we're looking for. Here's a histogram of what those returns would look like over the past 44 reported quarters.

Buying a call offers defined risk and would not take the punishment of some of those larger drawdowns, which is certainly appealing; that's probably what the May 675 call buyers were thinking. Keep big upside, but minimize the downside, shown here.

It's true that the downside moves were capped at just about 5%. Now the problem is that, because the stock has to move higher than the call strike price by the premium paid, it loses less on big downswings but loses more often. In fact, historically, spending 5% on an at-the-money call option expiring in two weeks would have resulted in a loss overall.

Here's where the call spread risk reversal aims to reduce the upside breakeven, reduce downside exposure, and increase the odds of success.

Notice that the call spread risk reversal would have won far more often than either buying the stock or buying calls. It still takes the risk of owning the stock, but because the short put option is 8% below the current stock price, the worst-case loss will always be at least 8% better than the risk of buying the stock, and losses of less than 8% in the share price are avoided entirely.

The tradeoff is that the upside gains are capped at 8%, and Meta has made moves much greater than that a few times following earnings, but overall, the improved win rate of the trade means the average historical performance of a trade like this is better than either long stock or a long short-dated at-the-money call. In this case, a trade like this would have averaged about 1.6%, or almost 29% annualized.

Risk less. Make more.