Update – Twitter Out

by riskreversal November 14, 2016 12:07 pm • Trade Updates

Shares of Twitter got a boost this morning when it was revealed that activist investor Jana Partners took a small stake.  I am not sure this news should be viewed too positively as it could mean short term turmoil for the company. Activists are likely to push for CEO and co-founder Jack Dorsey to make a choice between his CEO rolls at Twitter and Square. That could go either way, and it wouldn’t be a great look for TWTR if Dorsey chose Square after a fairly mediocre year since re-taking the the helm. And that would be on top of last week’s announcement of their 6 year veteran COO Adam Bain leaving the company.  The COO spot is being filled by former CFO Anthony Noto, a highly regarded former banker. But after two years of instability in the executive suite, a Dorsey exit would signal further disarray. But one bright spot would be that it finally gives an opening for the company to be sold. Supposedly the company looked to sell itself back in September but there was no buyer at the price they sought.

It’s our view that the stock is likely dead money until the company is able to demonstrate user growth and engagement that can only come from making the product itself more user friendly to the masses and less of an esoteric clique (for instance we’ve been using Twitter for years and conversation threads are still hard to follow, imagine being someone who just joined the platform). That push to make the platform more user friendly like Facebook has been missing since the founding, and rather than fix that they’ve spent the last 2 years chasing greater monetization of existing users.

If the company is not able to demonstrate growth after this Fall’s election season and their push into Live events (like their deal for Thursday night NFL football) when they report their Q4 in early Feb, then the stock is toast. At that point in the low to mid teens, there are no shortage of potential buyers, but I suspect it will be the likes of Salesforce.com who views the platform as a CRM product/platform rather than social network or short messaging service.

While we were optimistic of the prospects of a take-over for Twitter from a consumer internet or media company, their unwillingness to control trolls reportedly scared off large media buyers with family friendly reputations. It’s now a widely held view that the platform is a cesspool of trolls (the alt-right anti-semitism for example) and that’s unfortunate, because it seems so easily solvable with a more robust verification process for real people using real names. (Imagine a Twitter experience where you could sort by real, verified people and not even seeing the bile from eggs and alt-right neo-nazi frogs)

We wanted to take the time to update a trade idea we laid out last month:

The trade was for those who were still hopeful for a take-out after the flurry of rumors in Sept, but did not want to place a highly convicted bet that meant an initial premium outlay. Here was the trade idea from Oct 7th when the stock was just below $20, down from $25 the previous week, but up from $15 the previous month:

Trade: TWTR ($19.70) Buy Dec 16 / 24 Risk Reversal for even money
  • Sell 1 Dec 16 put at 65 cents,
  • Buy 1 Dec 24 call for 65 cents

Break-Even on Dec expiration:

Profits above $24, up 21%

Losses below $16, down almost 20%

Now with the stock $18.70, and a month away from expiration, it makes sense to re-assess this position, at least on the risk reward of the naked short put vs the very low probability of the long $24 call being in the money.

The Dec 16 put that was sold at 65 cents is now offered at 31 cents, and has a 17 delta. The options market is saying it has about a 17% chance of being in the money on Dec expiration. That will drop significantly as we get closer to Dec expiration if the stock remains well above the put strike.

The Dec 24 call that was bought for 65 cents is now 17 cents bid, with about an 11 delta.  This is just a lotto ticket at this point.

At this point it makes sense to de-risk the position as it appears a sharp decline is a greater possibility than a sharp rise. The position was established last month for even money, if you were to pay 31 cents for the Dec 16 put, and receive 17 cents for selling the Dec 24 call the position would result in a 14 cent loss.

It’s worth taking the time to consider that over the last month on a $1 decline in the stock, this position yielded only a 14 cent loss. If the stock was up $1 the gain would have likely been a bit small. So this trade structure gave up short term gains and losses, in return for the chance to be there for an explosive move higher. When it doesn’t work out, there’s not much harm, but you have to be vigilant to make sure you don’t leave cheap short puts on the table.

For the first time in a long time, we now have no position in TWTR. But we’ll continue to check back in on the story and see if another opportunity presents itself.