Using stock options as a safe bet for a Twitter buyout

Uncertainty around the election has resulted in declines for most stocks. Over the same time period shares of Twitter have been out performing the major indexes. This leads me to believe there may be a near term floor in shares of the micro blogging site.

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There’s no denying this Fall has been a roller coaster ride for Twitter which saw shares go up from $18 to $25 between Sep 28 and Oct 5 on rumors that Disney, Salesforce, or Google may pursue a bid to acquire the company. The speculation which fell short of an official deal produced a quick rise and fall. Solely on rumors. However, the price of the stock before the rumors began is basically unchanged (up some) even with the major indexes taking a beating!

If you can’t already tell I’m a believer in Twitter as a company with value. For investors and those on the long side, this rumor mill has done nothing other than show us what a potential bidder may be willing to pay for the company. More accurately it has shown us what Wall Street believes the perceived value of Twitter might be is if a buy-out (M&A) were to occur. This leads me believe that shares of $TWTR are worth $25 dollars a share, the price $TWTR flew at during the high of these rumors, and possibly worth more. If unknown bad news is released this could change my fundamental outlook but because I have sold options around my core position I can withstand a 25% drop (at a $18 price).

From the beginning, I looked at the rumor as a positive sign and started acquiring shares.

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I didn’t want to be overly aggressive on my first trade so instead of buying hundreds or thousands of shares I use options contracts to help me reduce my cost basis from $18.31 to $13.41.

Selling Put Options Contracts: I may choose to hold these options contracts through expiration and if the stock is below these strikes these contracts ensure the counter party of this trade that I will buy their shares at those strike prices (see details below for $16 & $24 strike puts). The counter party here is the person who bought this put option I sold. I’m basically selling insurance to shareholders who fear a price decrease or speculators who are shorting the stock. Selling this insurances puts money in my pocket which decreases my cost basis. It also increases the amount of stock I might own from 300 shares to 700 shares if I don’t close these contracts before expiration because I will be obligated to buy the stock.

If the stock price is above these strikes when these contracts expire I don’t have to buy more shares and because I am willing to buy more shares at a future date I have the benefit of collecting the premium up front to reduce my cost basis.

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Selling Call Options Contracts: I also sold the $18, $20 and $23 calls for and collected a $528 credit for the promise to sell the shares if the stock is above these strikes come expiration. Selling these Calls caps my upside. You can think of this as the opposite of selling puts because I’m promising to sell my shares come expiration if the stock is above these strike prices.

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I bought the $24 and $28 calls for upside.

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Putting it all together:

  • Collecting a premium in return to buy and sell the stock effectively reduced my cost basis to $13.41.
  • A move to $13.41 is a %24 drop from today’s closing price.
  • Selling call options caps my upside, however I sell options because I’m more concerned with protecting my downside than making gobs of money.
  • If Twitter’s stock prices stays the same between now and the time my contracts expire I will make money since these options expire worthless and I get to keep the premium I collected from selling the options. Then, I can sell more options to further reduce my cost basis if I choose.
  • A close above $30 come December 22 (standard options expiration date) will produce a decent size gain.
  • A close above $30 is a 71% move which is very ambitious.
  • Rather than expect a real buy-out to be a catalyst for a 71% move in the next month I like the idea of safely selling options while collecting a premium and reducing my cost basis.
  • If a buy-out happens I will still be happy!
  • Even if a buy-out doesn’t happen I can exit my position for a gain as long as the stock stays above $13.41 come December 22

On a side note, last night Facebook reported earnings which resulted in a %5.6 drop in share price. The decline in Facebook didn’t have a negatively correlated impact in $TWTR today. Not to mention the initial price action on $TWTR was positive after earnings compared to what happened with $FB.

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In summary, this rumor mill has provided a gift to us traders or anyone looking for an opportunity to be part of the acquisition.

Follow me on Twitter @Jeffreytief

The TachusChord website is for educational use only. Any opinions, news, research, analysis, prices, or other information contained on this website, it’s social networks, email distributions or any other material provide by the TachusChord and associated companies, employees or volunteers is provided as general market commentary, and does not constitute investment advice or a solicitation to buy or sell any stock, foreign exchange contract, contract for difference or securities of any type.

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Sell the TSLA news?

Tonight is the big event for Elon Musk and Tesla as they reveal the new Model 3 electric car. I must say, the hype around this day has been quite exuberant and very noisy. Don’t get me wrong. I am happy we’re finally realizing the need for efficient vehicles. I’d also like to think that I’m an environmentally conscientious person. I live in Washington State, one of the most beautiful places on earth surrounded by mountains, rain forests, lakes and rivers. I love where I live partly because of the beauty here and I greatly appreciate the need for us to shepherd our planet and keep it clean for our children’s children’s children…However, that has nothing to do with why I buy and sell stocks.

Watching TSLA’s parabolic climb, 70% off the Feb low, has been like watching a firework shoot up into the night sky on the fourth of July. Some of you may remember my blog on Feb 23rd and why I thought a short trade setup was occurring around the $180 price target, see here. Although I did well on the day-trade, my thesis that $180-$190 would provide some short-term resistance was dead wrong as the stock has since climbed up to a high of $240.

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The TSLA cult has pumped this stock well above the level I had imagined for the short-term. I’m not saying that TSLA can’t go higher. My point is that it has gone too high too fast and parabolic moves like this really don’t last long or end well. So, here I am once more beating the drum to short TSLA, however this time it’s for a different reason.  Many investors know it’s smart to buy the rumor sell the news.  Although, and in hind-sight, it would have been stellar to buy the rumor and participate in the TSLA stock rally, I think we are at a point where selling the news might be the right trade.

That is why I entered a very small yet speculative short position on TSLA. I bought the April 8, $240 put today when the stock was trading around $236 (Today’s high was 237.42 and low was $225). I only purchased one contract. I know, that doesn’t sound very exciting, but this contract cost me $1,400 and I really don’t want to take a huge gamble in-case my theory is wrong. I’ve been burned by taking on too much risk initially so in-case we do rally at the open tomorrow I’d like to save some dry powder and add to this position. I will be carefully watching how things unfold and if the TSLA maniacs are full steam ahead it will be best to cut my losses and run! Of course I think I will be on the right side of this trade and my idea may already be playing out. Notice the chart below and the sell-off before the close. TSLA fell from $237-$229. Will this firework explode soon?

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April 3 update: 

TSLA made a new all time high for the year after announcing the Model 3 but failed to maintain momentum into the day.

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On the morning after the announcement I faded the gap up and bought 1 more put option contract at the open when the stock was at $247. This was purchased near the high of the day. My average cost basis went down from $13.95 to $11.3 and my max loss as decreased 23%. I sold one contract rather quickly for $11.75 when the stock first went below $236 (see chart below). This seemed like the logical place to reduce my cost basis since it was close to where I originally entered the trade. Now I can sit more comfortably on my  remaining contract.

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You might think my one contract doesn’t inspire a lot of confidence in this trade idea, and admittedly you’d be right. Usually when my confidence is high I will take a heavier position but because TSLA is a hype stock and highly unpredictable I don’t want to bet the farm on this one speculation. However, I am confident that TSLA needs to take a breather and come down. The way TSLA traded the Friday after the big Model 3 announcement strengthens my argument that selling the news is a good risk/reward proposition for this speculative position. If the announcement was anything but baked into the current stock price shouldn’t it have held the gap on Friday, or at least closed above $240? The bulls will argue that strong pre-orders over the weekend, of almost 300K, is the catalyst to pump this stock higher but I’m not buying that as this number  will taper off and and cancellations pickup.

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I may add to this position and will let you know when anything changes!

There have been many articles published on Seeking Alpha about Tesla. Click to image below to see.

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