Name That Trade(s) – $TWTR: Bird Watching

by Dan February 5, 2015 2:12 pm • Commentary

Almost a month ago I laid out a bullish case for Twitter (TWTR), see below.  Shortly after detailing a bullish risk reversal, I decided to buy the stock instead of an options structure to express the view (read here and here), but I wanted to quickly re-visit this trade idea as we have gotten a few questions on it.  To fresh here was the trade idea from Jan 7th:

TRADE: TWTR ($37.42) Buy the Feb 32 / 42 Risk Reversal for 40 cents

-Sell to open 1 Feb 32 Put at 1.20

-Buy to open 1 Feb 42 Call for 1.60

Heading into the potentially volatile Q4 earnings event, this trade which expires in 2 weeks should be managed. With the stock at $41.41 the Feb 32 puts are offered at .25, so they have declined in value by 95 cents, that is a gain. The Feb 42 calls which are very near the money are now worth $2.70, so a gain of 1.10.  The whole trade is 2.45, 2.05 more than it cost.  Not bad, but it could all go to pot on tomorrow’s opening, or be a big winner, the risk/reward is binary.  No matter what I think, it makes sense to close the short put, remembering that the stock has had two 20% post earnings moves post results out of only 4 reports since going public, and makes little sense to stay short them.

The calls though will be the primary determinant of the trades success.  I would say there are two important choices to make. First either sell a higher strike call in Feb and create a call spread, locking in some gains of the trade, but limiting potential upside. For instance, if the position has a 2.05 gain, and you were too buy to cover the Feb 32 puts for .25, then you have 1.80 in profits to work with/protect.  One idea could be to sell the Feb 48 call at .85 and lock in that gain, and have on the Feb 42/48 call spread for 1.00, from that point risking 1.00 to make up to 5 if the stock is between 43 and 48 on Feb expiration.  If the stock is above 48, inline with the implied move, then you would make the max gain of 5, below 4 lose the 1.00, but have already locked in 80 cents in gains.

The other option would be to close the Feb trade all together book the profit and possibly use some of the gains to buy a longer dated out of the money call spread, participating in potential upside, with less sensitivity to a short term moves.

For those who are long stock, we detailed how we collared our long stock by selling a longer dated upside call, and bought weekly near our purchase price weekly put (read here).  

For those that have nothing on and are not inclined to buy the stock into the event but are bullish, the March 40/50/60 call fly for 2.50 makes sense as a good stock alternative. The risk is 2.50 as opposed to unlimited in the stock, and 50 is a pretty good area to target if this thing takes off. There is some risk you miss a massive move higher as profits trail off above 50, but that’s a small probability.

For those who want to target a move back to $35 on a disappointment over the next week, the Feb 13th (next week) 40/35/30 put fly for 1.20 looks attractive, with a break-even at 38.80, max gain of 3.80 at 35, profits trail off between 35 and 31.20, max loss of 1.20 below 30 and above 40.





Original Post Jan 7th, 2015:  Name That Trade – Twitter ($TWTR): Bird Watching

Twitter (TWTR) had a bad 2014 on many fronts.  Besides the stock closing down 43% on the year, execution was spotty and user growth was well below the growth rates investors have come to expect from larger social media behemoth Facebook (FB).  My best trade of 2014 was a long position in TWTR from mid summer to early fall, catching the move from the highs $30s to the low $50s (read here). The stock has a special place in my heart as 35% gains were not the norm in single stock positions in 2014. On the other hand I have a sort of  love/hate relationship with the company and the product itself. While the product is a very unique content distribution mechanism and a public communication tool, as an semi-active user the time-suck and the harassment from the trolling peanut gallery leaves me turning it off quite frequently.

But here is the thing, I believe that TWTR in its current form is NOT the product that will have 1 billion worldwide users, and the scarcity value of the property, the brand and the user base is NOT adequately reflected in stock’s $24 billion market cap.  I have made this argument for a while now, here, here & here and recently on last Friday’s Options Action on CNBC:

In 2014 FB paid $22 billion in stock and cash for mobile messaging service WhatsApp. At the time the company had about 500 million monthly active users with NO revenues.  Last night FB announced that WhasApp now has 700 million mau’s with 30 billion messages sent a day. There was no mention of revenues but that’s staggering growth nonetheless.  Here is the thing. Obviously first mover is important, but to compare WhatsApp’s staggering growth to TWTR’s stagnant growth is apples to oranges in my opinion.  WhatsApp is a messaging app that will likely do little more ever than send direct mobile messages.  Yeah, maybe there will be payment. But in general how many mobile ads will it take for these services to remain free?  There will always be some messaging system waiting in the wings to undercut those that want to inundate you with ads.  Shortly after the FB bid for WhatsApp I opined that Apple (AAPL) could possibly make a dent into WhatsApp growth by making iMessage available to non iOS users and possibly look to integrate other services like PAY (read here).

But back to TWTR. If WhatsApp was worth $22 billion last year to FB then TWTR’s $24 billion public market cap does NOT adequately reflect its scarcity value and the potential synergies of larger on-the-line companies that are sorely lacking a social media and mobile messaging strategy (See GOOGL, MSFT & YHOO to name just a few).

TWTR shares ripped yesterday closing up 7.5% on rumors and innuendo about possible activists stakes and/or potential suitors.  Crap like that generally pisses me off cause it all seemed a bit manufactured.  So here is the deal, if there is NO management shakeup, and NO m&a in the coming weeks I would suggest that the stock will once again test the low $30s: 

[caption id="attachment_49541" align="aligncenter" width="600"]TWTR 1yr chart from Bloomberg TWTR 1yr chart from Bloomberg[/caption]

My desired entry for a long position in the stock would be somewhere between the highlighted range above between the May lows and the recent support level at $35.  For an options position though the recent rise in implied volatility (the price of options) could mean put sales are an attractive strategy to either have some long biased exposure or help fund call purchases. Thirty day at the money IV reaching 70% today suggests that it will be a tad higher by the time the company reports their Q4 earnings on February 5th:

[caption id="attachment_49544" align="aligncenter" width="600"]TWTR 1yr chart of 30 day at the money IV from Bloomberg TWTR 1yr chart of 30 day at the money IV from Bloomberg[/caption]

So let’s talk trades. I will be a buyer of stock in the mid to low $30s, but we have gotten a lot of questions of late of how to play NOW for those who want to buy into the hype.

As a stock alternative or looking for leverage to the upside this is the trade that I would consider to play for some sort of corporate action, management trade, activist involvement or m&a between now and the company’s Q4 report:

HYPOTHETICAL TRADE: TWTR ($37.42) Buy the Feb 32 / 42 Risk Reversal for 40 cents

-Sell to open 1 Feb 32 Put at 1.20

-Buy to open 1 Feb 42 Call for 1.60

Break-Even on Feb expiration:

Profits: above 42.40, up 13%

Losses: up to .40 between 42.40 and 32, losses one to one below 32 plus the 40 cents premium paid for the structure.

Rationale:  This structure creates a fairly wide band of little to no loss or profit with massive potential profit in the event of an upside move like we saw in July post Q2 earnings. This is not a high probability trade given the wide break-evens, but if you are worried that the recent excitement results in fast money peeling out with no news then this trade offers the potential for leverage to the upside while little risk for another 13%.

Again, I will be a buyer of shares on a break of $35 and would possibly adjust these strikes down a couple of dollars if the stock was $35. Vol is rich, so short premium strategies are most attractive and risk reversal at least sell puts to finance the upside.