Name That Trade – $TWTR: #OverWrite

by Dan November 15, 2013 1:35 pm • Commentary

Earlier today we posted some details on the listing of Options on TWTR, just seven trading days after its IPO (here-TWTR Options Primer) and the conclusion on pricing of options is very simple, given the limited history of trading in the stock, options market makers will likely keep implied volatility elevated until they are able to get a sense which direction the stock will trade in the future.  This fact alone makes options on a fairly controversial stock like TWTR far more attractive to those inclined to sell them as opposed to buy them.  The likelihood of IV going much higher out of the gate is not great, and we can look at the pattern of IV after the listing of options in stocks like FB and LNKD back in 2012.

In Facebook, implied volatility spiked initially as realized volatility was also quite high when the stock quickly sold off after the IPO:

TWTR 30 day implied vol vs. 30 day realized vol, Courtesy of LiveVolPro
FB 30 day implied vol (red) vs. 30 day realized vol (blue), Courtesy of LiveVolPro

After that initial spike, 30 day implied vol (red) moved lower, finding a range between 45 and 60 until FB’s first earnings event.  After the stock dropped once again, implied volatility again inched lower, finding a bottom in the mid-40’s.

Since Twitter’s IPO has been a smoother process and rests in presumably stronger hands than Facebook, implied volatility has opened at a lower level than FB did.  However, Twitter is a smaller market cap company ($23 billion market cap) with no earnings, compared to mega cap FB which has a consistent, growing earnings stream. So the comparison is not perfect.

We have had a lot of questions this week as to how we think readers should be thinking about and trading TWTR options, and our sense the best way to take advantage of the elevated implied vol is to sell options against long stock, for those who are long and strong.

Hypothetical Overlay: Against 100 shares of long TWTR stock at $44 Sell 1 Dec 49 call at $1.00

Break-Even on Dec Expiration:

Profits: gains of up to $5.00 btwn $44 and $49.  With stock below $49 collect $1.00 in call premium or an added 2.2% in a month, annualized about 27%.  At $49 or above the stock is called away, plus you receive the $1.00 in premium, so your effective call-away level is up 13.5% in a month at $50.

Losses:  The call premium that you receive provides a 2.2% buffer to the downside, losses of the stock below $43.00

Trade Rationale: If you think TWTR could remain range bound for the next few weeks, somewhere btwn the highs made on the IPO day of $50 and the lows made this past Monday of $40, than taking advantage of the high implied vol makes sense in an effort to add yield.

I can not say that the buy-write, buying the stock and selling the upside call at current levels appears that attractive to me at the moment, as I don’t have a desire to be long the stock with a 4 handle, but for those long and strong, overwriting the stock in a systematic fashion could be a very nice way to lower your cost basis over time.