by Tyler Craig | November 18, 2013 9:14 am
Derivative traders rejoiced Friday as option contracts became available for the latest social media darling — Twitter (TWTR). Twitter options rolled out swiftly by historical standards, launching a mere seven days after the blue bird went public. Typically, options exchanges wait until a newly issued stock establishes a track record of healthy daily trading volume to ensure there will be adequate interest in any listed options.
Click to Enlarge In light of the warm reception greeting Twitter shares this past week — the average daily volume was north of 10 million shares — exchanges were quick to bring Twitter options to market.
Not just normal monthly options, mind you, but weeklies as well.
That’s right: The investing masses have some 30 strike prices in 11 different expiration cycles to play with. Needless to say, option addicts have choices aplenty to structure all types of Twitter options bets, from simple to complex.
And what of liquidity?
By Friday’s close, approximately 122,136 Twitter options contracts traded hands with put volume outdistancing call volume by a margin of 2-to-1. The high trading volume kept the bid-ask spreads around 5 to 10 cents, which means we have a green light for playing with them.
The one big X factor when new options are listed on a brand-new stock is volatility. With little prior price action to go off of, forecasting how volatile a stock is going to be in the future is a difficult guessing game. This can lead to egregious mispricing of options, increasing the chances that either option buyers are overpaying or option sellers are being inadequately compensated.
Fortunately, based on the scant data we have so far, option premiums appear pretty fairly priced on TWTR options from the get go. After its first full week of trading, Twitter’s realized volatility sits at 48%. The implied volatility of Twitter options rests around 53% — a slight premium to realized volatility making them appear neither ridiculously overpriced, nor an outright bargain.
And yet, if the implied volatility of Twitter options follows in the footsteps of options listed on LinkedIn (LNKD) or Facebook (FB) in their early days, it probably has a better chance of drifting lower in the future than higher.
If all this talk of volatility is making your head spinning, take heart. There are a number of ways you can structure directional bets on TWTR with options without exposing yourself to the vagaries of volatility. Vertical debit spreads are perhaps the simplest — because they involve both buying and selling options, the effects of volatility changes are muted.
With TWTR sitting in the middle of its trading range, I’m not a big fan of making big directional bets at this juncture. Consider waiting for a breakout in one direction or the other before entering the fray.
If Twitter breaks the $50 resistance level, buy a Jan 50-55 bull call spread. If it breaks support at $40, buy the Jan 40-35 bear put spread.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
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