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.
In fact, this TWTR sentiment backdrop deserves a few bullet points of its own before moving on to the remarkable world of TWTR options.
And in the world of Twitter options, we have the following "fun facts":
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.
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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