Name That Trade – TWTR: A #buy @support?

by Dan May 21, 2014 2:20 pm • Commentary

Twitter’s high volume selling on May 6th, after the end of the lockup period was on the highest volume in the stock’s history (higher than the IPO day).  The breakdown below the $38-$40 support area is unlikely to be recovered easily in the coming months, given all the overhead supply above there.  In other words, that’s huge resistance going forward:

TWTR daily chart, 50 day moving average in pink, Courtesy of Bloomberg
TWTR daily chart, 50 day moving average in pink, Courtesy of Bloomberg

On the downside, the $26 level marked in green is the IPO spot.  TWTR briefly dipped below $30 on the day after the lockup selling, but found ample buyers there.  $30 is probably the more relevant spot in the short run, where a retest low or minor new low below there could be a nice spot to play for a bounce back into the $30-$40 range where we expect the stock to spend most of its time in the coming months (with the main risk on the downside of that range rather than the upside).

We’re not the only ones that thinks the stock most likely takes some time at this new level. The implied volatility in options has come crashing down with the stock.

Screen Shot 2014-05-21 at 11.33.06 AM
30 day IV from LiveVol Pro

Significant spikes higher in vol between now and the next earnings report will likely only come from a sharp move higher or a bad breakdown from these levels. Situations that seem unlikely compared to what just transpired in the stock.

Comparing the damage done in TWTR stock to Facebook’s decline following its IPO you see that it took a while for investors to come back to FB (over a year) until investors were confident the company could monetize some new initiatives like mobile reach:

Screen Shot 2014-05-21 at 11.38.35 AM
FB 2 year from LiveVol Pro

TWTR stock is also likely to take its time and will need to demonstrate an ability to rekindle user growth and engagement.

TWTR won’t report Q2 earnings until early or mid August, and there are no scheduled corporate events between now and then.  Obviously the company could hold some sort of media/product event, as Facebook had been in the habit of doing to introduce new bells and whistles like social graph and their mobile Home initiative.  I would guess that TWTR management, already on the ropes, may be apprehensive to follow FB’s post ipo playbook and try to make a mountain out of a molehill for new products before they are proven in beta.

If that is the case, the next couple of months is likely to leave the stock range-bound, resulting in a further retreat of options prices.  A strategy we have used in the past to take advantage of similar situations are in the money butterflies, and one could be setting up nicely in TWTR prior to Q2 results.  Once we feel that TWTR is going to to hold the prior low at $29.50, we may look to put on the following trade:  

HYPOTHETICAL TRADE: TWTR($31.31) Buy July 30/35/40 Call Butterfly for $1.40

-Buy 1 July 30 Call for 3.00

-Sell 2 July 35 Calls at $.95 each (1.90 total)

-Buy 1 July 40 Call for $0.30

Break-Even on July Expiration:

Profits: btwn 31.40 and 38.60 make up to 3.60 with max gain of 3.60 at 35

Losses: btwn 30 & 31.40 lose up to 1.40, btwn 38.60 & 40 lose up to 1.40, below 30 and above 40, lose full 1.40.

RATIONALE:  We think there is a fairly low probability that the stock is above $40 in the next couple months, without some sort of very positive unexpected event.  On the downside we could see a re-test of the ipo price of $26, but again it would also take a bit more than a broad market sell off, and something specifically negative. For now we want to see the stock make another test of support and then a hold and we would be inclined to play for a mildly bullish range trade.  Stay tuned.