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Twitter Inc (TWTR): A Remarkable Situation

Dissecting the post-IPO price action and options activity in Twitter Inc

by 1/6/2014 8:14:52 AM
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The following is a reprint of the market commentary from the January 2014 edition of The Option Advisor, published on Dec. 26. For more information or to subscribe to The Option Advisor, click here.

"Remarkable" is an adjective I try to reserve (particularly regarding its use in my descriptions of stock market phenomena) for unusual circumstances that might also teach us a thing or two. And by more than one standard, the post-IPO action in Twitter (TWTR - $73.31) -- in its share price and its option activity, and also in the sentiment backdrop it has evoked -- has been quite remarkable.

To wit:

  • A 22% share price decline within weeks of its IPO-day peak at $50.09

  • A relentless 92% rally from its post-IPO low ($38.80) to today's high ($74.73)

  • A level of investor skepticism that, in this observer's opinion, makes the throng of analysts who panned Google (GOOG) before and after its IPO in the summer of 2005 appear to be blowing kisses at the "Google twins."

In fact, this TWTR sentiment backdrop deserves a few bullet points of its own before moving on to the remarkable world of TWTR options.

  • A national business and financial weekly identified Twitter as a "bubble" on the cover of an issue published more than 3 months before the IPO.

  • The average analyst price target among the 20 or so who cover TWTR is (as of this moment) $43.

  • In a December 16 Wall Street Journal article, it was reported that of the 24 analysts who cover TWTR, 16 currently had "hold" or "sell" ratings; the piece also cited "the skeptical chirping from some of the Wall Street firms that took the company public."

And in the world of Twitter options, we have the following "fun facts":

  • 904,000 contracts in total option volume today, with 618,000 of this volume on the call side (stay tuned)

  • Total option open interest approaching 1 million contracts

  • But perhaps most remarkable of all is the Twitter options phenomenon illustrated on the accompanying chart (courtesy of Trade-Alert); namely, that the daily fluctuations in 30-day, at-the-money implied volatility (IV) for TWTR options moved in the opposite direction from the pattern that would be described in the Equity Options 101 Guide for Idiots and Dummies, which informs us (with ample documentation) that equity option IV increases (often sharply) on share price weakness and IV decreases (usually gradually) on share price strength. And I'll shortly venture an educated guess for the "whys" of this.

But for the moment, let's take a look at the chart (click to enlarge), which sets forth a daily comparison of the TWTR share price (red line) and TWTR 30-day, at-the-money implied volatility (blue line). This chart calls out six specific TWTR price levels (P(n)) and accompanying IV levels (V(n)), with the first point occurring on IPO day and the last today. And what amazes me is how TWTR IV has tracked the share price action directly instead of tracking it inversely as "the book" would tell us.

Daily Twitter Inc (TWTR) contract volume since November 2013

Note that TWTR declines from its peak at $50.09 on IPO day (closing prices are shown on the chart, but in this case we also show the IPO day high) to a low close of $39.06 on 11/25; meanwhile, IV declines from 52.9% to 44.8%. IV then remains flattish as the stock steadily rallies by 10%+, but then IV pops by about 9 points and moves back above 60% on the 12/13 rally and (after a brief pullback in IV along with the stock a few days later) IV then surges to (I have to say it) the amazing level of 113% at today's close.

A possible explanation (which might also account for the explosion in TWTR call volume today) lies with the shorts -- those who engage in betting that share prices will decline and who have served in recent years to deprive hedge funds of bull market performance in a bull market. It strikes me that the shorts (their current TWTR position amounts to 23 million shares -- about 8% of the TWTR share float) were way too complacent in the days after the IPO, and had not done much in the way of buying calls to protect their negative bets on the stock from becoming savaged on a sharp rally. But then, at some point of "critical mass," the TWTR shorts became concerned (on their way to becoming panicked) and decided they'd better start buying TWTR calls in quantity. Unfortunately (for them), they continued to lag in their call hedges and needed to keep playing catch-up until today's climactic (perhaps) pop in TWTR call volume and IV. Put another way, the movement in TWTR IV (up and down) since the IPO has been determined mostly by demand from shorts for protective calls, with the shorts most complacent (where else?) at the share price bottom.

And all that call buying to hedge short positions? It served to translate directly into demand for TWTR stock, so the more the shorts belatedly "protected" themselves, the more their positions were in the hole.

So does today's feeding frenzy in TWTR calls mark a top for the stock? And does this less-than-flattering discussion of the activities of the shorts mark a turning point in their fortunes? Buy hedge funds in 2014? Stay tuned.


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