Following last week’s better than expected Q4 results from FB, and the stock’s subsequent 14% one day surge to new highs, we wanted to offer an alternative structure to those inclined to be long TWTR into last night’s Q4 print. While we are not long, and had no intention to be long TWTR, we had gotten a lot of questions of how we would play for a move back to the highs, and came up with the following structure that took advantage of unusually high implied volatility but offered a superior risk profile to being long stock if you were worried about the potential for a downside gap on earnings:
From Jan 31st:
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
So what now? With the stock trading below the short put strike at $55, the options have had a rough day mark to market, but the risk profile here is very different than if you owned the stock from around $65. The losses on the position at expiration begin at 55.50 and beneath, rather than the losses of having bought stock when it was $65.
So if you had this trade on as of last night’s close, you would still be in the hole today and possibly cursing your luck, but your position would only be in the hole by around $5, as opposed to the $13 that was lost in the stock since initiation. And this was the whole point of the exercise to offer what we thought was a superior way to be long the stock in the event of a move from $65 to $75 in the near term as opposed to buying stock at $65.
For purposes of managing this Hypothetical trade, the only thing I would be focused on is the short put, as the call spread is not worth selling, I would think about it as a bit of a lotto ticket.
So the put is worth about $5.30 with he stock about $52.75, at this point if I were short that put I would need to treat it like short long stock, and it is merely a market call. Do I think the stock stabilizes above $50 and works itself back towards my strike? Or does the stock break? At this moment, I think it make sense to let the stock settle, hell yesterday DDD was down 25% on the open and closed down 15%, and I’d much rather own TWTR here than that piece of crap.
Here’s how that risk profile looks visually, note the flat part of the graph from 65 down to 55:
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Original Post Jan 31st, 2014: Name That Trade – $TWTR: Quickly Trending to New Highs?
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:
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.
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.