Trading Twitter (TWTR) Options: What You Need to Know

optionsguy posted on 11/14/13 at 10:29 AM



TradeKing’s Brian Overby outlines key points for traders interested in TWTR options contracts, which are scheduled to begin trading Friday, November 15.

Twitter’s Equity IPO


As any market-watcher knows, Twitter (TWTR) went public last Thursday, November 7th. The company finally set the Initial Public Offering (IPO) price at $26 the night before. I say “finally” because the first projected range was $17 to $20 initially, that range was then moved up to $23, then to $25, before finally settling at $26. The next morning, opening print for the stock occurred just before 11:00AM ET at $45.10. The stock then spiked up and printed the high trade for the day, $50.09, before finally closing below its opening print at $44.90.


In the five trading days post-IPO, Twitter’s trading range has been between 39 and 47. But make no mistake: TWTR still counts as a potentially volatile stock with options likely to match.


TWTR Options


TWTR options are slated to begin trading on Friday, 11/15 - see this NYSE Euronext press release for specifics.


Trading both puts and calls on TWTR will be tricky at first. Expect wide bid-ask spreads on the option contracts until market makers have done some price discovery. What does that mean, exactly? The market makers’ hardest job with IPO option contracts is getting the implied volatility (IV) number correct for each expiration available. This is because there’s very little historical stock price data to go on. (If you’re unfamiliar with IV, read What is Implied Volatility in Options Trading? in our Education Center or watch this short video, Defining Volatility for Stock & Options Traders.)


So this means the option’s asking price may be artificially higher than the bidding price. This helps compensate for the risk of potentially getting this IV number wrong. This wider spread increases the overall cost to traders who want to invest in these options.


Outright buyers of puts and calls will want to be aware of a possible implied volatility crunch on the options after the first week of trading. Market makers will most likely spike up implied volatility to begin with, and you can get burned if the stock settles down quickly thereafter.


Finally, you should be aware that buying put and call options can result in the loss of 100% of your investment, should TWTR trade against you. (Learn more about long puts and long calls here.) Trading options on highly publicized IPO stocks is tempting, but it is crucial to understand the various forces at play with the pricing and trading of the option contracts besides the volatile movement of the stock price. You have officially been warned!


Learning from Facebook (FB)


A 2012 CNNMoney article reminds us that Facebook ($FB)’s IPO price was set at $38 per share the night before the opening trade on the Nasdaq stock exchange (5/18/12).  It then ended the first day’s trading session at $38.23. Since then it’s been a bumpy ride for Facebook: the stock has traded as low as $17.55 and recently made an all-time high of $54.83. Suffice to say the volatility of the stock price remained higher than expected for quite some time after the IPO.


Another important note: Most likely because of the volatility of the stock, FB attracted many short sellers to the table. The large amounts of shorts kept FB shares in a "hard-to-borrow" state for many months after its launch. If a stock remains hard-to-borrow due to high levels of short selling, it usually inflates put prices versus that of calls, independent of stock price movement and other option pricing factors. Why is this concerning? If the marketplace changes and shares become available to short the reverse happens with option contracts. The put prices will “deflate” comparably to the calls, once again independent of other option pricing factors. Just another need-to-know when trading high-flying IPO option contracts.


Now past performance does not guarantee any future result, but Twitter has definitely grown up alongside Facebook in this newly defined social media marketplace. Still, I think the comparison between these two stocks, and the options based on them, might be a fairly instructive one.


Option traders will be trading much more than stock price movement on the first day of option trading in Twitter. Now you’ll be better equipped to appreciate all the factors involved in trading these instruments. Good luck out there!


Regards,

Brian Overby

TradeKing's Options Guy

www.tradeking.com


[image: Twitter Logo from Twitter.com]


Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options available at http://www.tradeking.com/ODD.


Brian Overby currently holds no positions in any mentioned securities.


Online trading has inherent risk due to system response and access times that may vary due to market conditions, system performance, and other factors. An investor should understand these and additional risks before trading.


While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.


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Supporting documentation for any claims made in this post will be supplied upon request. TradeKing provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice.

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Posted by optionsguy on 11/14/13 at 10:29 AM

Comments

spshapiro posted November 14, 2013 (03:34PM)

It sounds like you are describing a situation that could be very beneficial to put sellers. Since you see a likelihood for an extra wide spread, there could be a possibility of being filled inside the spread and still benefit as the spread narrows through price discovery, and as shares are made available for shorting.    

optionsguy posted November 15, 2013 (01:01PM)

Hello SP,

In all things "options" there is always a good and a bad way to look at things. Thanks for pointing out an interesting good take on this blog.

With that said though, from a glance at the option chains today it doesn't look like the "hard-to-borrow" situation came to fruition. So the puts prices are not artificially inflated compared to the calls because of the short sellers piling on. At least not at this moment in time.

Regards,

Brian (Og)

spshapiro posted November 15, 2013 (03:48PM)

I didn’t get around to looking at the option chain until about lunchtime.  I noticed then that the spread was as tight as an ‘established’ stock at that time, at least for the near expirations. This isn’t a stock/option that I have much interest in, since I’m of the faith that I don’t sell puts on an underlying that I wouldn’t own at some price, and until they demonstrate that they can ‘earn a living’ I’m not given to wanting to support them. I’m of the belief that except for blood relations, there is no reason to support those that can’t demonstrate the ability to be self sufficient, now or in the near future.
Have a happy and health holiday season.

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