The Other Shoe Drops
Last time we wrote about Twitter (NYSE:TWTR), we suggested hedged longs consider exiting their positions, after the news that neither Alphabet (GOOG, GOOGL) nor Disney (NYSE:DIS) was interested in acquiring the social media platform. Now that Salesforce (NYSE:CRM) has bowed out as well, Twitter is down more than 32% since October 5th.
The October 5th hedge is still cushioning the blow for hedged longs. We'll recap the hedge and show how it's reacted to the drop below; then we'll consider what's next for Twitter.
The October 5th Optimal Collar Hedge:
As of October 5th's close, this was the optimal collar to hedge 1,000 shares of TWTR against a greater than 12% drop by mid-March while not capping an investor's upside at less than 8% by the end of that time period (screen captures via the Portfolio Armor iOS app).
As you can see at the bottom of the screen capture above, the cost was negative, so an investor would have collected an amount equal to $90 or 0.36% of position value (calculated conservatively, using the ask price of the puts and the bid price of the calls). Let's see where you'd be had you hedged on Wednesday and held through Thursday's collapse.
How The October 5th Collar Responded To TWTR's Drop
Here's an updated quote on the put leg as of Friday's close:
And here is an updated quote on the call leg:
How That Hedge Ameliorated TWTR's Drop
TWTR closed at $24.87 on Wednesday, October 5th. A shareholder who owned 1,000 shares of it and hedged with the collar above then had $24,870 in TWTR shares plus $1,700 in puts, and if he wanted to buy-to-close his short call leg, he would have needed to pay $1,790 to do that. So, his net position value on October 5th was ($24,870 + $1,700) - $1,790 = $24,780.
TWTR closed at $16.88 on Friday, October 14th, down about 32% from its closing price on October 5th. The investor's shares were worth $16,880 as of 10/14, his put options were worth $6,050, and if he wanted to close out the short call leg of his collar, it would have cost him $255, using the midpoint of the spread, in both cases. So: ($16,880 + $6,050) - $255 = $22,675. $22,675 represents a 8.5% drop from $24,780.
More Protection Than Promised
So, although TWTR had dropped by about 32% at the time of the calculations above, and the investor's hedge was designed to limit him to a loss of no more than 12%, he was actually down 8.5% on his combined net hedge + underlying stock position by this point. As with the parachute for 3D Systems (NYSE:DDD), this illustrates the impact of time value on a hedge designed to protect based on its intrinsic value alone.
As we wrote over the summer, Twitter is a potential goldmine, but it has jumped the shark with politically-motivated bannings. Seeking Alpha contributor Alex Pitti elaborated on this angle last week (Censorship Kills Potential Twitter Acquisition), and after he wrote that article, Twitter engaged in another politically-motivated move, temporarily suspending conservative journalist James O'Keefe, as Chicago-based trader and angel investor Jeffrey Carter noted:
With the NFL headfake fizzling, and CRM out of the running as a potential acquirer, Jeff Carter's question about who will buy Twitter becomes even more apposite. Perhaps a posse of deep-pocketed Twitter users/investors? Venture capitalist Fred Wilson, whose Union Square Ventures, tweeted a glimmer of hope for beaten-down Twitter longs on Friday, with 134 characters to spare:
The question for Twitter longs remains: at what price?
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.