Big Printin’ – Twitter (TWTR), and Long Alternative

by Dan August 4, 2016 3:53 pm • Big Printin'

Twitter (TWTR), you know the drill by now. The company is not growing users, revenue growth has decelerated massively (expected to be 16% this year and 13% next), profitability on a GAAP basis remains elusive, and investors have no time for any of it, with the stock down 22% on the year.  Last week the company announced results and guidance and the stock was down 15% the following day on July 27th, but has since nearly filled in the earnings gap. There is little fundamental reason for the 15% bounce, maybe a little sellers’ fatigue coupled with some of the normal takeover rumors.  My views on the replacement value for the company’s brand, 300 million strong monthly active users, tech and $2 billion plus advertising revenue base are simple… the company, with an $11 billion enterprise value is cheap for a strategic buyer like Google (GOOGL), to name just one. But it seems that the board is not likely to not sell the company prior to the upcoming one year anniversary of the return of founder and second time CEO Jack Dorsey

This week’s rumor was that number three and four holders, Saudi Prince Alwaleed and former Microsoft CEO Steve Balmer, who collectively own 9% of the shares outstanding would make a bid to take the company private.  If I were the board the only way I would do this would be for the wrong price, well above the rumored $27, which is only $1 above the company’s 2013 IPO price.  If the company were to remain a standalone I suspect it will have a much greater shot of success outside the public eye, but in my opinion given Snapchat’s reported $19 billion valuation, I suspect we would need to see a price tag in the high teens billions for the board to agree.  For a strategic buyer probably less, but that is likely to be a 2017 thing, and won’t even be current management’s decision one way or the other at that point.

Onto the options action in the stock. For the second straight day call volume is running very hot. Yesterday 220,000 calls traded to 84,000 puts, with total options volume more than 3x average daily, with short dated weekly calls (17,17.50 & 18s, 44k trading in total, most opening) making up nearly a quarter of the volume.  Whats important to note that this action is generally dominated by traders looking to scalp the intra-day move or catch a rally into the end of the week.

But in today’s action, where call volume is more than 3x that of puts there is a decent size longer dated bullish trade that caught my eye which speaks to a bit more conviction than of that in the weeklies yesterday.  When the stock was $17.80 shortly before noon there was an opening buyer of 15,000 of the Dec 20 / 27 call spreads paying $1.20, or $1.8 million in premium. If this is in fact an outright bullish trade then it breaks-even at $21.20, up 19% from the trading level, offering potential gains of up to $5.80, or $8.7 million between $21.20 and $27 with the max gain above $27.

While the break-even is a bit far, this could be a decent way to lever up an existing long position, but it is not exactly a great way to replicate long exposure from current levels. One way to lessen the premium outlay, and possibly lower the break-even would be to sell a put in December. The stock has found support around $14 on thee occasions this year:

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

If I were looking to lay for a similar move to the high 20s over the next 5 months or so what would that trade look like?

With the stock at $18 I would look out to Jan17 expiration  and sell the Jan17 15 put at $1.05 and buy the Jan17 20 call for $1.65 and sell the Jan17 30 call at 20 cents. This trade would cost 45 cents, breaks-even at $20.45, offers gains of up to $9.55 between $20.45 and $30 with max gain above. Between $20.45 and $15 I would lose the 45 cents, and the worst case scenario is I would be put the stock at $15, down 16.5% from current levels (plus the loss of 45 cents premium.

While the risk vs the potential reward in the Dec 20/27 call spread may screen as better than the call spread partially financed by the short put, the trade I detailed has a far greater chance of losing just a little vs the trade in December highlighted above’s chances of being a total loss.