Trade Update – $TWTR: Closing Buy-Write for a Gain

by Dan February 9, 2015 11:35 am • Commentary

Last week the company’s Q4 report got investors back onboard the Twitter (TWTR) story. We have twice bought the stock in the highs $30s (here and here) and dove into poor sentiment at what we figured could be at inflection points prior to earnings.  In the fall we sold above $50, and were hoping to do the same this time around. My bullish thesis has little to do with near term monetization of users and the growth of their user base, as I expect both be far slower than what was witnessed with Facebook (FB) in the years since its IPO. My bull case is because the company is a very scarce social media property that could have much greater relevance and scale within a larger media/internet company like Google (GOOGL). My view was based on sentiment and the potential for a take-over (or at least rumors of one).

I am a bit surprised that the stock rallied 16% on the results last week. Apart from showing their ability to make money on their existing user base, they still haven’t proven that they can expand that user base and ultimately grow into their valuation.  The company is trying to make the distinction between registered users (about 290 million) and the total audience (that could be as high as 500 million) and how they hope to monetize both groups.  Where I kind of lost Costolo was during an interview with CNBC’s Carl Quintanilla (who I thought did a tremendous job) on Thursday night. Costolo tried to place the blame for the loss of 3 to 4 million existing users on a bug in Apple’s iOS that lowered the net adds for the quarter. Watch here:

Carl’s follow-up about the “stickiness” of the service is a good one.  If a switch on iOS is enough to lose some of those 3-4 million users for good, were they really users? And if that’s the math we’re using, how many of the other MAU’s are one inconvenience away from never using Twitter again? And I thought Costolo’s response was weak.

So where do I sit right now? The lack of user growth remains a concern. As an investor I think its great that they are jamming more ads in users streams, but as a user not so much. I suspect as they become more intrusive with their monetization that will hit the sort of speed-bumps that FB did in 2012/2013 as it relates to ad loads and privacy concerns, but I remain confident that some of the new features should increase engagement and draw users to the platform.

But Twitter’s focus should be on mainstreaming the platform. The goal should be to mimic the sort of demographic reach that Facebook has and move beyond the niche platform that it is now. The Google integration is a positive step but more needs to be done and who knows how long that will take? Management does not exactly inspire confidence.

With sentiment obviously a bit more favorable than the end of 2014, the stock is up 30% in 2015. I am going to close my position (long stock, short call) and look to enter a stock replacement strategy with defined risk on a pull back to the mid $40s.  If anything, my disappointment with MAU growth but the better than expected revenues only increases my belief that GOOGL should buy them. But I worry that if it does not happen prior to TWTR’s Q1 report (expected in late April/early May) the stock could re-trace the recent move (as it did in Oct) if the company does not accelerate user engagement and growth immediately. So what I want to do is to close my current position and look to re-enter with a different position that sets up for a possible acquisition without the day to day risk of pullbacks in the stock:

Action: TWTR Sell to Close 100 Shares* of stock at $47.20 for a a $9.60 gain and buy to close 1 June 52.50 call for $3.10 to close, netting a $6.50 gain of 17% in less than month.

Now  will look for the proper entry and proper structure as a long stock replacement. A structure like the june 40/50 risk reversal makes more sense for out thesis at this point and if we saw the stock pullback a few bucks we could put that one for around even. Stay tuned.

* used 100 share increment to correspond with 1 call option contract.



Previous Post Feb 3rd, 2015: Trade Update – $TWTR: Collaring Long Stock

In the first week of January I bought shares of Twitter (see rationale below).  The stock has traded in a fairly tight range for  most of the year between $36 and $40, with the stock now back to the high end of the range, up 11% on the year:

TWTR ytd chart from Bloomberg
TWTR ytd chart from Bloomberg

Heading into Thursday night’s Q4 report I fear the higher the stock goes, the greater the expectations and greater potential for a disappointment.  Obviously I own the stock because I believe it will go higher over time but I am less certain that the company will be able to show the sort of monetization of their existing user-base and user growth and engagement that high growth investors have become accustomed to with Facebook. So while I hope for a good quarter, I don’t believe this is a quick fix overall and investors could be sell the news without meaningful improvement from Q3.

With that in mind I want to collar my existing long stock position, offering participation to the upside to a point, but limiting my risk on the downside. But I want to do this with a bit of a twist.

Rather than selling a call and buying a put of the same expiration, I want to sell a longer dated call to take in more premium at a higher strike and finance the purchase of a short dated put with closer to the money protection that covers the earnings event.

Trade: Against 100 shares of TWTR long $40: Buy Feb 6th weekly 37.50 / June 52.50 collar for even $

-Sell to open 1 June 52.50 call at 1.35 and

-Buy to open 1 Feb 6th weekly 37.50 put for 1.35

Break-Even on Feb 6th weekly expiration:

Losses: of stock between current level ($40) and $37.50 (my purchase price was $37.60), no losses below.

Profits: gains of the stock between $40 and $52.50 between now and June expiration, stock called away at $52.50 on June expiration.

Rationale: The idea behind this protection is that I’d be thrilled to get taken out in the stock at 52.50 and I think the stock is headed higher over the long term. But earnings events can be tricky and this structure basically locks in my entry price (37.60) for the event.  If the stock is up after the event, and the downside puts expire worthless I may look to roll the short call strike up and out a bit as I will essentially have on an overwrite.





Original Post January 8th, 2015: New Investment – TWTR: ReTweeted

Yesterday (below) I restated my bullish case for shares of Twitter (TWTR) in 2015. In sum, the stock’s $24 billion market cap, juxtaposed to Facebook’s $22 billion purchase price (cash and stock) does not adequately reflect the company and their product’s scarcity value as a premier social media property, and potentially important mobile messaging application.

As a standalone, TWTR is being undervalued in the current marketplace. And that is regardless of who is in the CEO post, or which activist investors may or may not own the shares.  The value in TWTR will be derived by the realization by a larger tech and or media company of the potential for the platform, and the synergies of a combination with a company like Google (GOOGL).  Concerns regarding market-share losses in GOOGL’s core search (read here), which hass been weighing on shares, could be just the impetus for the company to make a knock out bid for TWTR. Buying stocks on the hop for m&a is generally not a great investment strategy, but this one seems obvious to me. Especially if TWTR’s Q4 results do NOT demonstrate the sort of user growth and engagement that investors have come to expect from the torrid growth in Facebook over the last few years.  Earlier this morning I put in Quick Hits that I bought some shares:

Action: Bought TWTR at $37.60, fully expecting, and hoping to average down in the next few weeks.

Per the post from yesterday, I may look to add additional long exposure with defined risk using options, as the ideal entry would be between $35 and $30. So I don’t suggest the average down to be hedgey, but if the company whiffs on Q4/Q1 guidance, there is no activist involvement and no management shakeup, then the stock likely sees low $30s in Q1 which would be my preferred entry to load up and possible leverage up with options.



Previous 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:

TWTR 1yr chart from Bloomberg
TWTR 1yr chart from Bloomberg

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:

TWTR 1yr chart of 30 day at the money IV from Bloomberg
TWTR 1yr chart of 30 day at the money IV from Bloomberg

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.