Shares of Twitter rallied almost 5% on Friday after the acknowledgement that former Microsoft (MSFT) CEO Steve Ballmer took a 4% stake in the company and in an email to Bloomberg noted that he sees TWTR as a “unique opportunity” to invest in a co. that is “significantly undervalued compared to other tech stocks, like Salesforce or Amazon”. That’s all fine and good. Ballmer adds a shareholder with a steady hand (meaning not likely to sell anytime soon, and more likely to add on weakness with a long term time horizon), but I am not sure much else can be gleaned from his public statement. Remember, despite ably stewarding the monopoly software businesses that were Windows and Office he inherited as CEO in 2000 (until his ouster in 2014) Ballmer missed some of the biggest secular shifts in technology since the advent of the PC in the 1970s & 80s (mobile & social).
Over the weekend Barron’s Striking Price columnist Steve Spears offered up a put selling strategy for those interested in Betting on a Twitter Revival:
— Steve Sears (@sm_sears) October 17, 2015
Sears suggests that negative sentiment manifested itself (among other ways) in the stock’s short interest. And that provides an opportunity for short premium bullish trades into their much anticipated Q3 report on Oct 27th. That will be the first to feature their newly realigned management structure:
so many investors are aligned against Twitter that bearish short interest is at the highest level since October 2014. Short interest stands at about 46.1 million shares, up six million shares in the past two weeks.
As Sears is cautiously optimistic, and likes the idea of “legging into” a long through short puts (remember when you short a put if the stock is above the strike on expiration you merely receive the premium sold. If the stock is below the strike price you suffer losses below the difference of the short strike less the premium received). But looking at the one day implied earnings move of 12%, it appears that options market makers are just flat out cautious. In the seven quarters TWTR has reported as a publicly traded company the stock has moved on average the following day about 16%, with the two moves higher averaging about 18%, and the four moves lower averaging about 15%.
With the stock’s close of $31.15 on Friday, a 12% move would be about $3.75. I am long the stock. One strategy I’d consider to add leverage to my existing long (if I thought the worst was behind TWTR and that next week’s earnings event could serve as an explosive positive catalyst) would be a bullish risk reversal. This strategy includes a put sale as Sears’ suggests, but using the proceeds of the put sale to buy an upside call. For instance as of Friday’s close you could sell the Nov 27 put at 85 cents and use the proceeds to buy the Nov 36 call for 85 cents. On Nov expiration there are no gains or losses between $27 and $36, losses as if long stock below $27 (down 13%) and gains above $36 (up 15%) as if long stock. This is a low conviction bullish leverage overlay, but it’s a matter of how much risk a long holder is willing to add to an existing long into a potentially volatile event (to increase the probability of long participation one would need to tighten strikes closer to existing stock price are pay for the trade structure). We will be sure to take a closer look just prior to earnings as it makes most sense to use overlays close to targeted events to make sure you have chosen the proper strikes.
And lastly, using options against existing positions in a low or in this case zero premium manner can be exactly the sort of way to add alpha to your investment process in what is becoming an increasingly challenged return environment.