[Options] The Bird is the Word

Sean McLaughlin
October 7, 2020

The curious case of higher implied volatility in out-of-the-money calls than the correspondingly distant OTM puts continues in a lot of high flying names. This is neither good nor bad, rather a data point we can use to our advantage when crafting bullish trade designs.

One such name that's on our radar which also made the cut in ASC's latest Under the Hood report is everyone's favorite blue bird -- Twitter $TWTR.

This week, $TWTR has been trading above our level of interest and today's modest pullback offers us a good entry point.

As you can see from this chart, that's a pretty impressive base that's been built since mid 2018.

Here's what Steve Strazza had to say about it:

Twitter continues to outperform the broader market and this week price broke out and closed just above that key 46 level. We want to own Twitter as long as the recent breakout remains intact and target 75 over the next 6-12 months.

75 represents the measured move of the recent multi-year base that just resolved higher. It also happens to coincide perfectly with the company’s all-time high from just after its IPO almost 7 years ago.

Is $75 our date with destiny?

If it is, we'll have plenty of opportunity to take some meat out of the middle of this bird with a bull call spread.

Here's the Play:

I'm buying a $TWTR March 50/65 Bull Call Spread for $3.50 or cheaper. This means I'll be long the 50 calls and short an equal amount of the 65 calls for a net debit. This debit is the most I can lose in this trade if our expected move doesn't materialize.

I chose the bull call spread versus just long calls because there is some nice premium at the 65 strike that we can use to lower our cost of participation. Yes, this limits my upside, but that's a tradeoff I'm willing to make.

Note that Twitter has earnings coming up on October 29th which will likely come into play during our hold of this position. Accordingly, it's paramount that we size our position accordingly. If we suffer the max loss on this trade, it must be well within an acceptable loss for our portfolio. When it doubt, always go smaller.

Any close below $43 a share for $TWTR will invalidate my bullish trade completely and I'll look to close the trade to salvage whatever (if any) premium is left. In the meantime, I'll leave a resting order to sell this spread for a profit at $9.25. This would represent capturing 50% of the maximum possible profit (if held until March expiration). I hope not to have to hold the trade this long.

If you have any questions on this trade, please send them here.

~ @chicagosean

 

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