Tesla Inc (NASDAQ:TSLA) and Twitter Inc (NYSE:TWTR) are both momentum (or momo) stocks. Usually these are fast-running stocks where most of the buying and selling is done on faith rather than science. That means conviction is based more on speculation, and not so much valuation.
Before you send out the posse to get me for calling TSLA or TWTR stock speculative, let me explain what I mean.
When Apple Inc. (NASDAQ:AAPL) fell to $90 per share, I went long with conviction based on pure valuation versus price math. Price fell to a level where Apple shares were a slam-dunk buy based on income, cash and stock price.
Compare this with any long trade I’ve done on TSLA stock. My thesis has never been about valuation. Around $200 per share, I sold puts in Tesla expecting that buyers would step in to support the stock. At $225 and $255 per share, I wrote about going long based on pure technical breakouts.
Just last week, I wrote about the opportunity to profit from TSLA stock even if it stalled. Over $3 in profits came fast. So I need to roll out of those profits and find another place where risk is less obvious.
My portfolio almost always has a small portion reserved to speculative trades. As I close my spec trade on Tesla stock, I want to roll the risk into a bet on TWTR shares.
Why Twitter? Especially when I’ve been so vocal about their management’s incompetence?
Last week, Wall Street negatively reacted to Twitter’s earnings report in a violent manner. TWTR stock fell 15% in a matter of hours. But what got my attention more so than Twitter falling off the cliff was the high number of downgrades to “sell” from the analysts. This sounded like capitulation in coverage, where almost everyone gave up on the idea of higher prices soon. If I am correct, then this greatly reduces the number of incremental sellers.
This would also give me levels against which I can sell risk.
How to Trade TWTR Stock Here
The first bet: Sell the TWTR Jan 2018 $13 put for $1.40 per contract to open. By selling naked puts, I am committing to owning Twitter stock at $13 per share if it falls beneath it. My breakeven point would be $11.60 per share, and anything below it would then accrue losses for me. This trade has a 15% buffer from current price and a 70% theoretical chance of success.
TWTR stock would have to repeat the drop from last week and set a new all-time low for me to start losing money. Nevertheless, I could modify this trade to being a credit put spread, thereby greatly reducing the worst-case scenario.
The alternate bet: Sell the TWTR Jan 2018 $13/$10 credit put spread, but for only 85 cents per contract. That said, in this structure, my max risk is defined to the width of the spread less what I collect to open the trade.
Both trades have the same odds of success.
Someone who is optimistic about a buyout could use some of the premium to buy calls, but this is not for me. While I do believe that there could be support here, I have zero faith that TWTR management could pull off a miracle.
I am not required to hold these trades open through expiration. I can close them at anytime for partial gains or losses. I could even buy sacrifice penny priced puts to give me cover for the next few weeks.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.