Uncovering the Strategy: Selling Covered Calls on Meta Platforms Inc.

What is happening?

Tech investors were on edge after Meta released its Q1 earnings report with disappointing outlook on Wednesday after the markets closed. Tech sentiment rebounded slightly on Thursday when both Microsoft and Alphabet reported strong earnings. However, the fear in tech world persists as more earnings reports are coming ahead, particularly from Nvidia. 

Meta exceeded expectations with their strong first-quarter results. The company’s net profit in Q1 rose by $12.4 billion as the total revenue, mainly from advertising ads, saw a remarkable 27% increase to $36.5 billion. Investors retreated after the social media giant provided a conservative guidance for the upcoming quarter with signs of rising expenditure, which overshadowed the optimism surrounding AI.

CEO Mark Zuckerberg projected that investments in AI will bring Meta’s full year 2024 capital expenditure to be in the range of $35 to $40 billion, up from the previous range of $30 to $37 billion.  He emphasised the need for investors’ patience as the company made its move into AI.  According to Zuckerberg, “building a leading AI will be a larger undertaking than the other experiences we’ve added to our apps, and this is likely going to take several years”. However, Meta's caution about taking several years for the AI investment to yield significant returns raised concerns about the sustainability of AI spending. A similar situation occurred  in October 2022 when the company disclosed investments in the Metaverse and Virtual Reality, leading to a 25% decrease in share price.

What can you do?

For investors holding Meta for long-term investment and believe in upside potential of the stock from its AI investments, may consider selling covered call options on Meta. This strategy enables investors to earn premiums from the call options, providing additional income while they wait for Meta’s share price to reach their desired target.

Steps:

1. With Meta’s stock price at $443.29 on 26 April 2024, selling a call option with a $480 strike price (if you are comfortable selling your Meta shares at $480) for less than 1-month expiry (25 days) will yield a total premium of $510.00 ($5.10 x 100 shares).
2. This gives an annualized yield of 16.6% (5.10/443.29) x (360/25).
3. If Meta’s price falls below $480 (strike price) on 24 May 2024(expiry), the option may expire worthless, and the investor keeps the premium.
4. If Meta’s price rises above the strike price of $480, the investor is obligated to sell the share at $480, but the investor still keeps the option premium.

When comparing to options with longer maturity, you can observe how this alters the premium you receive and the distance over which you will be able to set the strike.

• If the investor wishes to receive more premium, the investor can go for an option with a longer expiry. For the same strike at $480, the premium increases to $6.05 as the duration increases to 32 days on 31^st May (annualized yield = 15.4%).
• If the investor is only willing to sell the stock at a higher price but still want to receive a similar premium, the investor has to choose the option with a longer expiry. For a similar premium of $4.55, you can sell the option with the strike $510 and expiry in 53 days on 21^st June (annualized yield = 7.0%).
• The table below shows how the premium yield changes as we adjust the strike price and expiry date. The premium yield is subject to many factors including how close the strike is to the current price as well as market moving events surrounding Meta. 

Annualised yield of Meta options with different Strike and Expiry

Advantages of covered calls

• Generates passive income. Selling a covered call generates an income via premiums that can supplement the overall return of a portfolio.
• Relatively low risk. As the risk of being short a call is covered with your stock position, this is a relatively low risk way to trade options.
• No extra margin required to sell covered calls. As you hold the underlying stock for delivery, there is no extra margin required to sell the same number of covered calls at Saxo.

Risks of trading covered calls

• Capping your stock’s upside potential. One key risk is the loss of opportunity to profit from your stock’s potential upside above the call option’s strike price.
• Risk of using covered calls as a proxy for take profit orders: In the example above, it is possible that the stock trades well above $480 through the course of the option but on expiry falls back below $480. Without the option, the investor might have booked the profit at $480 but because the stock was covered by call options, the investor might have waited out until expiry.

Options are complex, high-risk products and require knowledge, investment experience and, in many applications, high risk acceptance. We recommend that before you invest in options, you inform yourself well about the operation and risks. In Saxo Capital Markets' Terms of Use, you will find more information on this in the Important Information - Options, Futures, Margin and Deficit Procedure. You can also consult the Essential Information Document of the option you want to invest in on Saxo Capital Markets' website.
This article may or may not have been enriched with the support of advanced AI technology, including OpenAI's ChatGPT and/or other similar platforms. The initial setup, research and final proofing are done by the author.