Name That Trade – Twitter (TWTR): Catching a Failing Whale

by Dan May 9, 2014 3:36 pm • Commentary

Looking back on the week that was it is hard to find a bigger story than the collapse of Twitter following its IPO lock up on Monday evening.  For the rest of the week traders have been actively debating where to take shot for a bounce after Tuesday’s one day decline of 19%, See me and my Fast Money friend Tim Seymour debate it last night:

The stock could set up for a short term oversold bounce here as $30 seems like a logical nice round number for the stock to hold after such a dramatic decline but I am in the camp that the stock probably touches its IPO price of $26 at some point in the future before all is said and done.  The stock will set up for a fantastic longer term long entry at that point, but not yet:

Earlier today there was an interesting bullish trade in Twitter that caught my eye. When the stock was $31.84 this traded in pretty good size (2500x):

Trade in the Market (not us!):

Trader Bought TWTR ($31.84) Sept 27/35 Risk Reversal for 1.00

-Sold 2500 Sept 27 puts at 2.20

-Bought 2500 Sept 35 calls for 3.20

Break-Even on Sept Expiration:

Upside: Profits above 36, up about 12%

Downside: put the stock at 27, but really at 28 when you add the premium paid, so down 12%, between 28 and 35 lose 1.00 in premium, or $250,000

 

What I find most interesting about this trade is that the trader likely sees some support in the high 20s, above the $26 ipo price, with potential for a bounce back to the mid to highs $30s.

The one year chart below shows the $40 breakdown level from earlier in the week, that should serve as staunch resistance on the upside.  There is no real support aside from the low on Wednesday of $29.50 and obviously then just the ipo price of $26:

TWTR chart since inception from Bloomberg
TWTR chart since inception from Bloomberg

One other point to make about this trade is that the trader chose to sell downside premium to help finance the upside bet as implied vol (the price of options) remains very high, but with more than 200 million shares coming unlocked this week (not including the insiders who said they wouldn’t sell), the increased float should dampen vol a bit, while short interest is also likely came down. The one year chart below of 30 day at the money IV shows the fairly dramatic recent decline in option prices in TWTR that will likely persist.  The trader of this structure probably hated the idea of sitting long out of the money calls that would just decay at faster rate than would be expected which is why the puts were  likely sold in conjunction with the call purchase.

TWTR 30 day at the money IV from Bloomberg
TWTR 30 day at the money IV from Bloomberg

Because TWTR seems like the momentum stock that reached its revulsion stage before most of the others, we’d likely look to do a similar structure to play for a longer term oversold bounce. We’d love to be able to do that at the IPO price of $26, and would only even begin to think about it once the stock was below $30. The stock could me in the midst of a decent short term bounce off of $30 right now, but we really feel that that $26 print is in the cards before the all clear signal for a longer term play can be made.

 

 

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