Twitter (TWTR) Long Alternative

by Dan July 26, 2016 2:41 pm • Commentary• Trade Ideas

Earlier I offered a preview of Twitter’s (TWTR) Q2 results due after the close (here).  My long bias for the stock has been consistent (and wrong) since early 2015. At some points though, usually before earnings events, rather than owning stock, I have created trade structures with options that mitigate near term gap risk in place of near term upside participation. One such trade structure has been a bullish risk reversal.

As I detailed this morning, the implied one day post earnings move in the options market for TWTR is about 10%, or about $1.3 billion in market cap, or nearly 12% of the company’s enterprise value. If this is not the sort of event risk you want in your trading, but want to have exposure to an upside gap, the following trade may be of interest. This is where some of that ol charting comes in. Being mindful of the technical support level I laid out earlier at $14, and technical resistance at $21, it may make sense to lean on those levels in an effort to allay near term risk:

From Bloomberg
From Bloomberg

With the stock at $18.30, you could look out to December expiration (also catch the Q3 earnings report that will come in late Oct) and sell to open one Dec 15 put at 95 cents, and buy to open one Dec 23 call for 95 cents.  This trade offers gains above $23 on Dec expiration, up 25% and losses below $15, down about 18%.  There is clearly skew towards calls, which could suggest that traders sell less downside gap risk as opposed to upside.

This trade has about 50 deltas, meaning in the near term for every dollar the stock moves the trade should move about 50 cents for or against you depending if in the direction of the long call, or short put.  What this means is that on a mark to market basis, the trade will show losses as the stock declines closer to the short put, and gain as moves closer to the long call. As time passes though both options will decay, lose deltas and become less sensitive to movement if the stock remains far from both the put and the call.

This trade offers no initial premium outlay, but is basically a takeout trade offering leverage to a big gap, possibly in the event of a takeover. Worst case is that you are put stock down at $15 on Dec expiration.

If you were a bit more convicted you could sell a the Dec 16 put at $1.30 and buy the Dec 20 / 27 call spread for $1.30.  This trade structure again has no initial premium outlay, but has a cap on potential gains as you could make up to $7 between $20 and $27 with max gain of $7, or 38% above $27 on Dec expiration. Worst case scenario, you are put the stock at $16 or lower.

Just food for thought, you have options 🙂