This Twitter Trade Could Return 138%…

The common notion that good things come in threes is a bit ridiculous. And nothing proves this more than Twitter’s earnings this week.

After Facebook and Snap reported their above-average earnings recently, many expected equally strong numbers from Twitter. It somewhat delivered with top and bottom-line beats. But its Q1 and fiscal 2019 forecasts disappointed in a huge way.



The social media giant did deliver on the revenue growth it promised, with a quarterly $909 million in sales. That’s significantly above analysts’ $860 million estimates. Even so, the company’s own forward-looking projections quickly quelled any enthusiasm investors might have had.

To start, monthly active users (MAU) – the most important quarterly number for many in the social media world – fell again. This isn’t really a true surprise. The company has, finally, started to close accounts that are clearly bots and fake. We’ve all heard those stories throughout news cycle after news cycle. And this trend will continue.

But Twitter also decided to change things up. It is now going to stop reporting this MAU figure going forward. Instead, management notes it is switching to the dubious “Monetizable Daily Active Usage” number.

Basically, this is Twitter’s attempt to appear it is growing its user base, when it really isn’t. This figure is essentially: how many subscribers it can throw ads at on any day. It’s not quite the same as “Here are all of our users. Make of it what you will.”

Nonetheless, some numbers just can’t be fudged. Twitter told investors during its presentation this morning that first-quarter revenue will likely come in at the low end of analysts’ estimates.

Worse, operating expenses – primarily related to it cleaning up its site from the aforementioned toxic bots and fake accounts – are expected to skyrocket.

Analysts expect the cost of this clean up to run about 12% higher in terms of 2019 operating expenses compared to 2018. Twitter now says they’ll run about 20% higher, significantly eating into its margins.

All of this sounds worse than it truly is. Twitter is, after all, still growing both top and bottom lines. But investors are going to remain wary of its stock.

Because of this earnings announcement, shares are down nearly 10% on the day. If these numbers hold, it will have officially crashed through both its 200-day and 50-day moving average, with any kind of support still a way off:

twtr.png

It could fall as low as $28 or even $26 per share from here before it finds any kind of floor. That gives traders a great opportunity to play this downside. Sure, it has already fallen more than $4 just this week. But it has farther to fall.

Let’s take a look at the best way to take advantage…

A Trade For Short Term Bears

A bear put spread is a type of trade that involves two put options. To enter it, a trader would need to purchase a put option on a stock he believes will fall. Then, he would have to sell a second put option with a lower strike price. This does two things.

It first captures profits for any share price decline down to the lower strike price. Second, it reduces the amount of money at risk to enter the trade. The premium from the sold put offsets some of the cost of the long put.

In exchange for that reduction in entry costs, the bear put spread trader would give up any profits from shares falling through the bottom of the sold put option. Meaning, if shares keep falling well beyond what the trader expects, he won’t profit from that extra movement.

Here’s how this kind of trade looks in chart form:

bearputspread

Source: The Options Industry Council



As you can see in this hypothetical example, profits increase for the trade as the share price declines (x-axis) until it hits $55 (the strike of the sold put). However, the amount of money at risk is capped as well.

Let’s look at a real example of this strategy being used on Twitter.

A Specific Bear Put Spread Trade on TWTR

If a trader agrees that Twitter is in for further share price declines in the short term, he might employ this bear put spread strategy.

To enter a trade, he could buy March 15 $31 put for $1.85 per share and sell a March 15 $29 put for $1.01 per share for a net debit of $0.84 per share. Since each leg of this trade represents 100 shares of TWTR, that’s a total entry cost of $84 for this specific bear put spread.

That’s the total the trader would have at risk. To find the total profit potential of this trade, take the difference in strike prices ($31 – $29 = $2) and subtract the cost to enter the trade ($2 – $0.84 = $1.16). On 100 shares per contract, that’s a maximum profit of $116.

A $116 profit would be a 138% return on the $84 at risk. To lock in that full profit, shares of TWTR would have to fall below $29. As we noted above, a fall to $28 or even $26 is actually pretty likely.

To put this in perspective, if the trader were to short shares of TWTR, he’d make just 6.2% as shares fell to $29. That’s why this strategy is regarded as equally lucrative and relatively low risk. And it’s the exact right one to use on TWTR’s expected decline.

 

— The Option Specialist

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About the Author: The Option Specialist