Facebook Inc Remains Tier 1

At Tier 1 Investments, a Motley Fool Real-Money Portfolio, I seek out and invest in elite businesses. These include companies with companies with the strongest competitive advantages, largest growth opportunities, and best management. It's an investment philosophy that has handily out-performed the market, with Tier 1 earning a time-weighted return of 74.63% since inception on Sep. 1, 2011, compared to the S&P 500's 62.41% return during that time.

Back in September 2013, I added Facebook to the Tier 1 Portfolio. At the time, I felt that Facebook's excellent leadership team led by founder and CEO Mark Zuckerberg had the social media giant well positioned to profit from the enormous global growth opportunities that lied ahead for the company, and was widening the already-deep moat around Facebook's network. That all remains true today.

Yet shares are down nearly 20% from their 52 week highs as bears have begun to question Facebook's acquisition strategy after large multi-billion dollar acquisitions of WhatsApp and Oculus. While the price tags of these two acquisitions certainly raised eyebrows, Facebook also received criticism for its Instagram acquisition, which is now widely considered to be a success. It will likely take longer for us to know whether acquiring WhatsApp and Oculus were also wise decisions, but both acquisitions have tremendous potential. WhatsApp, in particular, is very interesting because it gives Facebook access to its 450 million active users, 72% of whom use the service on a daily  basis. It also gives Facebook ownership of WhatsApp's massive global communications platform, which processes a massive number of messages that is believed to be roughly equal to the total volume of SMS messages.

On the other hand, Oculus -- as a leader in "immersive virtual reality technology" -- doesn't quite seem to fit with Facebook's stated mission to "make the world more open and connected." In addition, Oculus has yet to release a consumer product, with its virtual reality headset still at the prototype stage. But I'm intrigued by the many potential uses for Oculus' virtual reality technology, as well as the future applications its talented team will produce as part of Facebook's seemingly ever-expanding empire.

Are these two acquisitions worth $19 billion and $2 billion, respectively? At first glance, the answer seems to be no. But Zuckerberg and his team have earned my trust, and I will be patient as I wait to see his vision come to fruition.

Tier 1's strategy
I want to increase Tier 1's ability to profit alongside Facebook, before Facebook's true potential - and that of its many acquisitions - comes to light. But I want to do so in a more conservative manner than simply buying shares to account for the possibility of further downside in the months ahead. To do so, I will be selling puts on Facebook. With this option strategy, I will be paid a premium to enter a contract to buy 100 shares of Facebook at a specified time and price. Specifically, I will be selling the Facebook January 2015 $50 puts, currently trading at about $4.60 per share. If Facebook is trading at or above $50 on the Jan. 17, 2015, expiration date, the puts will expire worthless. And the $460 I receive in premium ($4.60 per share times 100 shares) will amount to an approximately 9% gain on the $5,000 at risk ($50 per share times 100 shares).

If Facebook is trading below $50, I will be obligated to purchase shares at an adjusted price of $45.40 ($50 strike price minus the $4.60 per share in premium), or about 25% lower than today's $60.50 price. I think it's also important to note that I would be buying Facebook in January 2015, after the company will have had time to grow its earnings and cash flow significantly. So, in effect, I would be buying shares of the social media king at a better valuation than is possible by simply buying shares today. And, importantly, I'd be very happy to purchase Facebook's shares at that adjusted $45.40 price.

Finally, between the time I sell the puts and the expiration date, I will have the option of buying back my puts or rolling them to other strike prices and/or expiration dates. And so, with this put writing strategy, there will be many ways to earn a profit.