Using stock options as a safe bet for a Twitter buyout

People holding mobile phones are silhouetted against a backdrop projected with the Twitter logo in this illustration picture taken in  Warsaw September 27, 2013.   REUTERS/Kacper Pempel/Illustration/File Photo     GLOBAL BUSINESS WEEK AHEAD PACKAGE - SEARCH "BUSINESS WEEK AHEAD JULY 25" FOR ALL IMAGES - RTSJGEW

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.

past6days

 

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.

twtr_costbasisowned

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.

TWTR_Puts.PNG

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.

twtr_calls

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

twtr_calls_debit

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.

twtrvsfb

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.