Twitter Inc (NYSE:TWTR) reported earnings and so just as Caterpillar Inc (NYSE:CAT) did yesterday, it popped and now is falling to -5% fast. Traders have been fickle this earnings season. We have seen great companies report awesome quarters yet get punished because of one reason or another.
Equity markets in general are nervous. A slew of scary headlines litter the ticker tape, so investors have to worry on several fronts. Fears of tariff war between the U.S. and China loom over the markets. We have fears of rising rates. We are also unsure on how the new U.S. Federal Reserve chair will handle the rate hike cycle from here and how will that impact equities in general.
So the fears are warranted but some cases overdone. Twitter stock is not cheap from the traditional sense. Its price-to-earnings ratio is astronomical — but the platform is priceless. For a long while, its future as a company was questionable. Investors were waiting for the headline of a takeover which never came.
Then came President Donald Trump, who in my opinion saved Twitter stock and the company’s current form. For better or worse, it has unofficially become the way the White House disseminates news. Anyone interested in politics has no option but follow Mr. Trump on Twitter. So use of the platform has never been more popular.
Profitability is another matter but for now the stock is on rails and has non-traditional intrinsic value that should create support below. While I am not optimistic about a rally, I am certain that it will have a floor for the coming months. And therein lies my opportunity today.
Instead of chasing upside hopium, I want to sell downside risk against levels I deem strong enough to hold this year. The idea here is that I don’t want to risk my money by buying TWTR shares outright, but I do want to generate income with no out-of-pocket risk.
Trading TWTR Options
On its last earnings report, Twitter stock had a reset. It jumped from trading below $27 per share to reaching $36 per share. It has since fallen to test the breakout level, but so far it has held above it. Today’s move will again test the zone but if it holds would solidify the prior resistance as forward support.
For the next few months, the technical risk now becomes that very same breakout neckline. If the bears are able to push the stock below it, TWTR could then overshoot lower and perhaps retest a prior pivot level around $23 per share. This is not a forecast, but a downside scenario for which I have to plan.
Using Twitter options allows me to build in a buffer large enough to make room for a potential downside scenario that may or may not come. Given the value of the platform, I am confident that if I am put the stock at a big discount from current price I will be able to manage out of it with relative ease.
The Bet: Sell TWTR DEC $21 naked put for $1.10. This is a bullish trade where I have a 80% theoretical chance for maximum gains. Otherwise, I will own shares and accrue losses below $19.90.
Selling naked puts carries big risk especially for a stock as frothy as TWTR. For those who want to mitigate it, they can sell a spread instead.
The Alternate Bet: Sell TWTR DEC $21/$19 credit put spread. The spread has the same odds but would deliver 20% yield on risk. Neither trade require a rally to profit. In fact the stock can fall an additional 25% and I could still retain maximum gains.
Since there are no guarantees when investing in stocks, I never risk more than I can afford to lose.
Learn how to generate income from options here. 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 as @racernic on twitter and stocktwits.