Name That Trade – $TWTR: Take These Broken Wings

by Dan April 24, 2015 1:50 pm • Commentary

With the first two weeks of Q2 earnings coming to a close, I think it is safe to say that investors seem a tad unfazed by slight misses (that have been explained away from currency headwinds) sending the S&P 500 higher by nearly 2% on the week and the Nasdaq Composite up more than 3%.  While the market has inched higher we have seen our share of some large moves in some high profile tech stocks.  Most notably the 18% one day rally in Netflix (NFLX) following their better than expected subscriber numbers, and then today’s 15% gains in Amazon (AMZN) on the heels of their higher than expected profitability.  In my mind, both of these stocks and their related trade set-ups into their prints shared one very important commonality, they are two of the most controversial stocks in the entire market, where it appears that bulls and bears have dug in.

Here were my concluding thoughts from my NFLX preview last week:

If you wanted to play what may be trend (or may just be random noise), the stock should rally Thursday. Or maybe the rally into earnings was investors realizing this trend and trying to get ahead of it. (Trading is fun!)

If the stock is going up, it is going through $500, and there will be no overhead resistance. But vol is pretty high.

Here were my concluding thoughts from my AMZN preview yesterday:

I’ll be wrong forever on this stock. While I am a very happy long term customer of Amazon, I have not once ever considered the stock a rational investment. Last year the company had $89 billion in sales, and registered an operating profit of only $178 million. I am not a fan when it comes to investing in the belief of a man, like Jeff Bezos, and the promise that one day all of his spending will results in insanely great profits. To me this is a greater feels scenario. With the stock within 5% of its all time high, I think its safe to say that the story as articulated to investors seems to be resonating, just not for me.

It’s pretty clear that the idea of shorting either was not palatable to me into the prints, and despite their large moves after, I still don’t have the desire to do so now.

Which brings me to another fairly controversial on-the-line stock that we have traded profitably on numerous occasions from the long side over the last year, Twitter. (My long biased thesis links here.)

I am long TWTR, but I remain a bit worried about monthly active user growth (MAUs). Where Facebook continues to grow MAUs in the low teens percentages year over year off of a massive base, TWTR has struggled to do so in the mid single digits off of a user base one fifth the size. On the flip side the company has made a ton of tweaks of late to improve user experience. They have added a lot more ads and have launched their live video streaming app Periscope in the quarter.  As they did last quarter I suspect investors will give the company a pass if user MAUs and engagement does not increase meaningfully qtr over qtr, but they need to clearly articulate how much of the recent moves will do so in the near future.

The stock is clearly controversial, as it is expensive, and does not have the sort of growth on the user front to suggest it will be at Facebook’s scale for a decade.  That said sales growth is huge at an expected 70% yoy and they could be on the cusp of ramping monetization.

MY VIEW ON MY CURRENT POSITION: I am considering an options strategy that offers less at the money risk into the event of a near term decline, but offers leverage in the event of a sharp move higher to new 52 week highs.

The options market is implying about an 11% one day move which is shy to its 5 qtr average of about 16%.

I would also add that the technical set up is kind of interesting.  The stock has been basing above $50 for the last month, has held the Q4 earnings gap level above $45 since early Feb and has little overhead resistance until the 52 week high at $56:

$45 is massive long term support (green line) as it corresponds with the stock’s 200 day moving average, and has been a breakout and breakdown level for the last year. This is a level I’d want to be very careful being caught long below.

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

With the earnings report on Tuesday after the close I think it makes sense to time it to choose strikes as close to the event as possible, but if the stock were here a couple hours to Tuesday’s close, this is the trade that I would put on to replace long stock:

Trade: TWTR ($51) Buy May 52 / 60 Call Spread for 2.00

-Buy 1 May 52 call for 2.75

-Sell 1 May 60 call at .75

Break-Even on May 1st Weekly Expiration:

Profits: between 54 and 60 I can make up to 6, max gain of 6 above 60

Losses: up to 2 between 52 and 54, max loss of 2 below 52

Rationale:  TWTR is up 42% on the year. Expectations are obviously high. If investors have any reason to feel the story has hit a speed bump the stock will be back in the mid $40s, possibly on its eventual way back to $40 in short order.  That said, given the way investors have rewarded high valuation stocks that have delivered on growth metrics of late, this stock could be off to the races back above the 52 week highs in a quick. While I don’t love the idea of owning short term long premium into an event, and one that is priced so expensively, I have gains in the stock, and I prefer to go from an undefined risk position to one where I know exactly what my downside is. Also, if the stock is going up I am hard-pressed to think it is does not at least squeeze back to the prior 52 week high at $56.