Name That Trade – $TWTR: Quickly Trending to New Highs?

by Dan January 31, 2014 1:06 pm • Commentary

New Media stocks are partying like it’s 1999 to steal the phrase.  IN the last few weeks, the standouts in Q4 earnings have come from the likes of FB, GOOG and NFLX, pushing all three stocks to new all-time highs. Extrapolating from FB and GOOG, the online ad environment is strong, and it is white hot in mobile.

Next week, TWTR will report their first quarter as a public company, and frankly the options market is taking its cue from FB’s post earnings volatility.  Since FB’s IPO 7 quarters ago, the stock has averaged about a one day post earnings move of about 12%.  With TWTR at $65, the options market is suggesting a one day move about 16%, with 30 day implied volatility already quite elevated even without an earnings situation:

TWTR 1yr chart of 30 day at the money implied vol from Bloomberg
TWTR 1yr chart of 30 day at the money implied vol from Bloomberg

For newbies to the options world, the chart above makes outright purchases of near dated options for directional purposes into next week’s event a very difficult proposition to make money.  You would need quite an outsized move given the high options premiums.

For those who think there is a distinct possibility that TWTR acts similarly to FB following next week results, the high price of options actually creates a very attractive set up for those who are willing to be net short options.

We have gotten the question on more than one occasion since yesterday’s 14% gains in FB. How Would We Play for New Highs Next Week In TWTR??

For those who are comfortable being short puts below the market, as opposed to just buying stock at current levels, the high IV makes certain Risk Reversals VERY attractive.

First, let’s look at the technical levels that we will use to inform our strikes.  The chart since IPO below shows near term support in the mid 50s, just below the 50 day moving average at $55.75.  This would be a decent level to sell puts to finance the purchase of upside calls.  On the upside, the all time high of almost $75 looks like a very reasonable target, and a spot that could find logical technical resistance.

TWTR chart since IPO from Bloomberg
TWTR chart since IPO from Bloomberg

For those who are inclined to buy the stock at $65 playing for a move back to the previous highs, we would like to introduce an alternative structure that offers a much more favorable risk reward.

Hypothetical Trade: TWTR $65 Sell the March 55 Put to Buy March 65/75 Call Spread for .50

-Sell 1 TWTR March 55 Put at 3.00

-Buy 1 TWTR March 65 Call for 7.00

-Sell 1 TWTR March 75 Call at 3.50

Break-Even on March Expiration:

Profits:  btwn 65.50 and 75 make up to 9.00, max gain of 9.00 or 14% of the underlying above 75

Losses: btwn 65.50 and 55 lose up to .50, below 55, down 15% you are put the stock and suffer loses

Rationale:  This structure essentially participates in the next $10 of TWTR stock upside, without risking the next $10 of TWTR stock downside.  The caveat is that you cap your gains on TWTR above 75.  So for those who see a move to 100 in the next 6 weeks, this isn’t the right structure for you.  But for those who are positive on the stock but want to give themselves downside room just in case, this might be a better way to be long TWTR into the event rather than simply buying the shares here.