$TWTR’s Moment

by Dan February 22, 2016 2:28 pm • Commentary• Trade Ideas

Shares of Twitter hit a new all time low on February 11th, after reporting Q4 results that for the most part disappointed investors. Since then, shares have rallied roughly 30%. Despite the recent gains, the stock is still down 20% on the year, down 30% from its November 2013 IPO price of $26, and down 75% from its all time highs made in December 2013.  Sadly, for now the recent rip looks like nothing more than a counter-trend rally of an epic downtrend:

TWTR since Nov 2013 IPO from Bloomberg
TWTR since Nov 2013 IPO from Bloomberg

Taking a slightly shorter term view of the chart, the one year chart shows the stock now butting about against the downtrend that has been in place since their Q1 2015 results that caused the stock to drop nearly 20% the next day on April 28th and has barely seen an uptick since.

TWTR 1 year chart from Bloomberg
TWTR 1 year chart from Bloomberg

Into the recent earnings announcement, options prices had spiked to all time highs but have since been cut in half, with 30 day at the money implied volatility at 62%, down from 118% nearly two weeks ago.  If the stock were to settle in or continue its counter-trend rally, then options prices should continue to moderate, making long premium directional trades challenged. That means financing the purchase of long dated options by selling shorter dated ones that much more attractive:

TWTR 30 day at the money implied volatility from Bloomberg
TWTR 30 day at the money implied volatility from Bloomberg

My positioning: A month ago when the stock was $18.80 (read here) I bought back the stock, and it quickly went down 25%.  After a little averaging lower after results, I am now above water on the trade.  For any of you who were wondering how accurate my crystal ball is, that should clear things up a bit ¯\_(ツ)_/¯  But, I would say that the next identifiable catalyst will be Q1 earnings expected in late April and despite a lot of new initiatives, I would be surprised to see a material pick up in monthly active users. Or engagement for that matter.  TWTR’s return to user growth is a multi-quarter, and possibly year long endeavor.  But I remain steadfast on the potential of the platform, and the product.

The company needs a sort of aha! moment that leaves investors and shorts massively offsides in one of the very few unique mobile/social platforms on the planet.  That moment likely comes with some sort of partnership with a huge media or technology company, with the pie in the sky potential for an outright buyout, but I suspect the board is willing to give new management a little time.

So what’s the trade?

For those with costs within a few dollars from here, I think it makes sense to consider long stock alternatives that take advantage of elevated options prices, allow for defined risk over a potentially volatile period, but also allows for significant leverage to the upside in the event the company has that sort of aha! moment.

So this is what I’m doing. I’m closing my recent stock purchase (which is a slight loser) and the 1×2 overlay on it (which is a slight winner) and replacing it with a simple risk reversal out in June:

Stock Replacement (in lieu of 100 shares of stock):

*TWTR ($18.50) Buy June 15 / 23 Risk Reversal for even money
  • Sell to open 1 June 15 put at $1.20
  • Buy to open 1 June 23 call for $1.20

Break-even on June Expiration:

Profits: above $23

Losses: below $15

Neutral: no gains or losses between $15 and $23, but on a mark to market basis before June expiration the position will show losses as the stock moves lower close to the short put strike, or gains as the stock moves closer to the long call strike.

Rationale: This is an effective way to be involved in the stock for a sharp move higher while not risking anything in the stock unless it was below 15 on June expiration. This is for those willing to buy the stock (i.e. be put the stock with the short put) for $15.