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Facebook options activity soars from day one

NEW YORK (MarketWatch) -- Like the stock before it, Facebook Inc. options debuted Tuesday with a record-setting flurry of activity, as traders bet the beaten-down stock has farther to fall.

Activity in options, contracts that allow investors to bet on the direction in which Facebook stock will move, soared Tuesday to a record for any option making its debut, according to data provider Trade Alert.

"You don't usually see this incredible first-day volume," said Joe Kinahan, chief derivatives strategist at retail brokerage TD Ameritrade. "The markets have been very liquid, which is very good for the [individual] investor."

The largest option trades bet on Facebook continuing to fall. The biggest trade used options known as puts to wager on Facebook slipping to $25 a share by mid-July. Puts are contracts that give the buyer the right to sell stock later for a set price. Late Tuesday afternoon, shares were trading around $29, heading toward a new closing low.

The surge in options activity wasn't seen as a good thing for Facebook's stock. The shares' decline, analysts said, was partly attributable to pressure from "short" sellers, who sell stock they don't own with hopes of replacing it later at a cheaper price. Market makers--or professionals who take the other side of investors' trades--would have been likely to sell Facebook stock short as they sold puts. Selling stock short offers protection if market makers later are obligated to buy stock from those who have bought puts.

"When you see a lot of people buying options that profit should the stock fall, that may drive the stock price downward, because of the steps market makers have to take to protect their positions," said Brian Overby, senior options analyst at TradeKing.

Interest from small investors and professionals pushed activity in Facebook options to more than 312,000 contracts. With each contract giving the right to buy or sell 100 shares of Facebook stock, that amounts to about 31.2 million shares of Facebook. Among company options, only those of Apple Inc. (AAPL) were more active.

While bearish bets drew the most activity, the Facebook options traded all over the board, with some investors seeing a jump to $65 a share by January 2014 and others predicting a slump to $16 a share by December.

Most Wall Street analysts covering the company think the stock is worth far more than its current price, with firms that recommend clients buy the stock putting price estimates on Facebook at between $40 and $48 a share. Even some firms with "sell" ratings on the stock think the company is worth at least as much as the current trading level, with two firms that advise selling shares targeting a $30 price.

A significant portion of the activity in Facebook options Tuesday came in small batches of contracts, according to Jeff Shaw, head of trading at Timber Hill, indicating smaller traders were very active in the market.

"There is a fairly large individual [investor] presence in this activity," he said.

June $30 put options were among the most-actively traded options, with more than 22,000 bought by the late afternoon. That gives traders the right to sell as many as 2.2 million shares of Facebook at $30 each by June 16.

With the stock price moving in reaction to options-market activity, "this could be a case when you see the tail wagging the dog," said Mark Sebastian, chief operating officer at OptionPit.

Thanks to the high demand for put options, some traders saw opportunities in selling them.

Douglas Estadt, the founder Pennwall Capital, which has $10 million under management, said he had sold 65 contracts in June $26 puts and June $25 puts as a means of collecting income while taking advantage of a good entry point to buy the stock.

Selling the contracts, which cover 6,500 shares of Facebook, allowed Estadt to collect between 20 cents and 35 cents a share. If Facebook's stock stays above the $26 level, Estadt gets to keep those proceeds. If the stock falls, he has the opportunity to buy the shares for a total cost of about $25.65 and $24.80 a share.

By selling the contract, Estadt is obligated to buy Facebook stock at the $26 and $25 level if the buyers choose to exercise their right to sell.

"Either way, I'm doing pretty well. Either I collect the premium or own the shares very cheaply," Estadt said. "I'd be happy to own Facebook at these prices. Facebook is profitable, and I think it will grow."

However, less-optimistic traders used put options to set up positions that would profit most should the stock drop to $25 a share by July 21. In the largest Facebook option transaction as the session neared its end, one trader bought the right to sell 305,000 shares of Facebook at $32 each by July 21 with puts, while granting another trader the right to sell the same number of shares at $25 a share.

While the trade cost $2.95 a share, the trader can profit as much as $1.2 million, or $4.05 a share, if Facebook falls to the $25 level.

--Alexandra Scaggs contributed to this article.