Selling puts of Twitter (TWTR - Get Report) can help investors generate additional income as the social media company faces headwinds amid missing estimates in the fourth quarter and downgrades from Wall Street.
Against additional pressure, Twitter's shares continued their decline on Friday, dipping by another 4.4% mid-morning to $15.70 as the microblogging social media company reported fourth quarter revenue of $717.2 million, an increase of only 1% annually and below a $740.1 million consensus analyst estimate.
Wall Street analysts reacted immediately as Citi and UBS downgraded the stock to sell, Pivotal Research and Deutsche Bank changed their ratings to hold, Atlantic downgraded to underweight and Cowen and Raymond James downgraded to underperform.
Although Twitter's stock continues to tumble, the descent remains above an April 2016 low of $13.73. Even though the stock is being pummeled, investors can take advantage of the slide and sell some of the volatility, said Ron McCoy a portfolio manager on Covestor, the online investing company, and founder of Freedom Capital Advisors in Winter Garden, Fla.
While McCoy does not hold any shares of the company, he has generated returns by selling puts underneath. In his LOWS fund at Covestor, which is up over 7% year-to-date, he regularly sells puts to boost income.
Since Twitter has over $5 per share in cash, the cheaper the stock becomes, it increases the likelihood that another company will acquire it, he said.
By selling the January 2018 $10 puts for $0.41 in his LOWS fund, McCoy took advantage of the increased volatility.
"Every company has a price and we believe if the stock were to get significantly cheaper from here, we would see buyers start to line up, said McCoy: "At $10 per share, the company would have a market cap of $7 billion and is a good acquisition target since it is holding over $3.5 billion in cash with debt of $1.6 billion."
Following its third quarter strategy, Twitter opted not to give formal sales guidance, even though it had in previous quarters. Twitter's ad revenue remained flat at $638 million, missing a $657 million consensus while behemoths Facebook (FB - Get Report) reported ad sales rose 53% in Q4 to $8.6 billion and Alphabet's (GOOGL - Get Report) rose by 17% to $22.4 billion.
Twitter "desperately needs to re-think its flawed" business model, compared with other competitors, such as Facebook and LinkedIn," said K.C. Ma, a CFA and director of the Roland George investments program at Stetson University in Deland, Fla. The company's platform for advertising is cumbersome, which means companies turn to FB or LinkedIn (LNKD instead.
"For an average user, it is virtually impossible to grow your followers, unless your are Donald Trump or Kim Kardashian," he said. "But traffic is traffic and the total traffic is driving the ad income as the advertisers ... just want more people."
While it is unlikely Twitter will not reach its highs again, the lows from 2016 are not likely to be revisited immediately, said Meredith Zidek, a Hunt Valley, Md.-based options and ETF trader.
"But I would count on the lows making a comeback before Twitter returns to the $19 level," she said.Selling strangles is a strategy Zidek likes to follow. A strangle which is the purchase of a call and a put with strike prices that are above and below the current stock and helps investors capitalize on big moves in either direction.
The June or September contracts offer enough premium to make a strangle "worthwhile" since the June 14 strike puts currently trade for $0.62 and the June 19 calls trade for $0.82, Zidek said.
"The combined premium on the June contract allows for a margin of error outside the $14 to $19 range of nearly a dollar and a half, assuming the goal is to avoid taking on any shares but rather to simply close the contracts," she said.
The September 14 puts trade for $1.05, and the September 19 calls trade for $1.30."With either strangle, all the premium would be retained as profit with no stock transaction taking place unless the strikes are breached at expiration and should the shares be put to the trader, the premium provides a nice offset in cost," Zidek said.
If Twitter's shares reach $19, "at the very least, the premium received from the puts provides a little income while the short calls must be dealt with," she said.
Investors who believe the shares will rise should keep the puts open for maximum gain and buy a number of shares to transform the calls into covered calls.
"At the expiration, I would be happy to have the shares called away for a capped profit as the calls are exercised by the buyer," Zidek said. "Another outcome might be that the purchased shares might then pull back and never reach the call strike and I'd be stuck holding a bunch of Twitter shares. But, at least I would have the premium from the calls and the puts to allow me some leeway in managing the shares to ensure a profitable disposition of them."