Trade Update – TWTR: Closing May Put Fly for Double

by Dan May 6, 2014 9:35 am • Commentary

When we made a bearish trade in TWTR 2 weeks ago, we identified 3 main reasons:

First and most importantly, that the investor fever had broken for high valuation/high growth stocks and while they were all not likely to implode in a straight line, the potential for a continued correction was far greater than the potential for new highs any time soon. Second, that the company’s Q1 results were not likely to show any material improvement from the issues that marred their Q4 results sending the shares down 24% in a single day. Lastly, that despite some insiders and early investors suggesting that they would not sell their almost 200 million combined shares on last night’s lockup, there were certainly plenty of the remaining 280 million shares that would be for sale given the stock’s gains from the ipo.

Well, here it is, the moment of truth, or at least one of the first moments in many unfolding truths. The stock is down nearly 7.5% this morning, making new lows with no support until the stock hits the $26 IPO price.

However, I don’t think that is coming today so I have a choice to make. Does the early selling abate and the short covering take over (the last reading on Bloomberg showed short interest at 40%), or does the onslaught of those looking to lock in whatever gains they can outweigh the short covering, and the stock gets sloppy?

It’s a tough call, but I figure it’s nice to take the trade off on the big lock-up day rather than risk some immediate short covering. It’s a nice winner that played out as we intended so not worth the risk on the profits with only a week and change left until the position expires.

Action: TWTR ($35.55) Sold to Close May17th 40 / 30 1×2 Put Spread* at 4.30 for a 2.20 gain

* There is no need to sell the May 24 Put that I own as part of the original put fly, think of it as a lotto ticket.





Original Post April 25th, 2014:  New Trade – TWTR: Greater Fools Parade Has Ended

Updated April 26th @ 8:40am w/video from last night’s Options Action (below), and yes, I got a bit screamy.

I am going to keep this really simple people, ITs OVER.  The love affair with high valuation/high growth tech stocks is done.  Investors can’t stomach owning pure speculation at any price.  The uptrends that have been in place in social media, 3d, cloud and biotechs have now done an about face and are all in massive downtrends, and just as these stocks overshot on the upside, they are now very likely to do so on the downside.

We have talked about this on numerous occasions over the last few weeks/months (see linkfest below), but the price action this week in AMZN, FB, LNKD, NFLX, NOW & P convinces us that it’s over.  Some of these stocks may never again see the 2014 highs, and others might not for a very long time.

Chart of the Day – YELP: All Bounces Are Not Created Equal

MorningWord 4/21/14: Ominous Burrito Reversal Pattern Forming in Netflix?

MorningWord 4/17/14: Choppy Seas

MorningWord 4/11/14: Different This Time? 

MorningWord 4/9/14: Sifting Through the Dotcom Rubble

MorningWord 4/4/14: New Highs in $SPX No Cure For This Virus – NOW SINA TWTR

MorningWord 1/15/14: Sagging DDDs – XONE, DDD, SSYS

MorningWord 12/26/13: Are We There Yet?? Market Tops Usually Preceded By Overzealous M&A

Twitter is going to be the next one to watch, as they are set to report Q1 on April 29th after the close.  The options market is already implying about a one day move of about 15%, which will likely increase as we get closer considering the stock’s 24% decline on February 6th, the day after the company reported their first quarter as a public company (THIS WAS THE EXACT POINT WHEN THE BUBBLE WAS PRICKED, most social media/ web 2.0 stocks were at new all time highs, then came Facebook’s soon to be infamous WhatsApp acquisition two weeks later…..and it was A, B, Cya!!!).

It is my sense that all of the issues that investors hated about the company’s user growth (lack there of) and anemic user engagement are likely to be prevalent in the results from Q1 (despite headline beats on earnings, revenues & margins).  And then the following week, on May 5th, (to trade May 6th) 465 million shares come unlocked for sale from insiders and early investors. The stock popped earlier in the month when some investors/employees said they would not sell, but let’s be honest, the IPO came at $26, the stock is $42.63, still up 63% from its issue price.  Sure, it’s a far cry from the all time highs near $75 in December, but it still beats a sharp stick in the eye for IPO investors.

If the gig is up, those inside these sorts of companies or those early investors in some of these overvalued companies are likely to know before all the suckers who bought them in the greater fools parade of the last couple years.  My thesis doesn’t mean that many of these companies won’t continue to dominate their respective businesses.  It just means that the bubble like price action in their stock certificates has been pricked, and many of the stocks will see lower lows from here in the near future.

Now as regular readers know, I wouldn’t short many of these oversold stocks with my worst enemy’s money at this point (prior to a healthy bounce, which may come from lower levels). Why?  Cause it’s these sort of stocks that can gap 10-15% in a heartbeat, and that risk is silly for anyone other than a nimble trader with a healthy risk budget.  But I do like to define my risk and make a risk/reward bet that fits my thesis. So here is the trade but with one big Caveat: Generally we are not huge fans of pressing shorts that are very oversold (as many of these web 2.0 stocks are) down 20% or 30% in a short time, but we have had some recent success of late defined risk bearish shorts (FB, LNKD, NFLX, TAN), and we think the set up here is attractive in TWTR, despite its oversold condition.  We are risking what we are willing to lose.

TRADE: TWTR ($42.25) Bought May17th 40/30/24 Put Fly for 2.10

-Bought 1 May 40 Put for 2.61

-Sold 2 May 30 Puts at .29 each or .58 total

-Bought 1 May 24 Put for .06

Break-even on May Expiration:

Profits: Max profit of $7.90 at $30, profits of up to $7.90 btwn 37.90 and 30, profit trails btwn 30 and 24

Losses: up to $2.10 between $37.90 and $40 with max loss of $2.10 at or above $40.

The downside risk below 30 is removed due to the ability to buy the 24p for 5c as opposed to a balanced fly with the 20 puts for the same price. The position would make $1.90 at any point below $24. Here’s how it looks on a PnL chart:

Profit / Loss chart on May expiration, Courtesy of Bloomberg
Profit / Loss chart on May expiration, Courtesy of Bloomberg

RATIONALE:  TWTR’s post-IPO low is $38.80 from late November, marked in green in the daily chart (the red line is the IPO price of $26):

TWTR daily chart, 50 day ma in pink, Courtesy of Bloomberg
TWTR daily chart, 50 day ma in pink, Courtesy of Bloomberg

The stock has held above that support level in April, though it is approaching it again on this week’s selling.  The 50 day ma has been declining ever since the stock’s earnings miss in February.  A bad report next week, and $38.80 support could break with a big gap.

Implied volatility is high in TWTR, near 80, but that’s not outrageous given that 10 day realized volatility is above 70:

30 day implied volatility in blue, 10 day realized volatility in white, Courtesy of Bloomberg
30 day implied volatility in blue, 10 day realized volatility in white, Courtesy of Bloomberg

With the earnings event next week, options look fairly priced, if not slightly cheap.