Twitter Stock: My Risk-Reward Trade (NYSE:TWTR)

You can’t read any financial website or watch any financial television station without seeing something about Twitter (TWTR) these days. It is an ‘everybody has an opinion’ stock. News flow on the stock has been constant, with the latest being a terrible earnings report and a five day trial between the company and Elon Musk set for October in Delaware.

Merger Background

On April 25, Twitter agreed to sell itself to Elon Musk in a $44 billion cash deal or $54.20 per share. The price marked a 38% premium to the stock’s closing price on April 1, the last session before Musk disclosed a 9% stake in the company. Musk was a fan and user of Twitter, calling it ‘the digital times square’. The deal included a $1 billion termination fee.

Almost immediately the spread on the deal was at 10 percent or so despite the fact that there didn’t figure to be any significant regulatory issues. Why? The market never fully trusted Musk. Why? Despite being one of the smartest and most successful people of his generation he has a reputation of making unusual or seat of his pants decisions:

• The purchase price of $54.20-Musk likes to make reference to “420”. You don’t need to be a top Wall Street analyst to understand how Musk came up with the deal price.
• Eight days after the deal announcement to take Twitter private Musk said he would want to take Twitter public at some point.
• Just 18 days after DA, Musk said the deal is on hold due to the large number of spam/fake accounts.

On July 8, Musk said he was terminating the deal.

On July 12, Twitter sued Musk to keep him from walking away from the deal, saying that the termination is invalid and wrongful.

On July 19, The Delaware Court of Chancery set an October date for a five-day trial between Twitter and Musk. Musk had wanted a longer trial and one in 2023 so this news is seen as a victory for Twitter.

On July 22, Twitter announced that they had missed its earnings and revenue forecast. They blamed the distraction from the Musk saga and tough current economic conditions.

The consensus opinion is that the contract is tight and Musk will not be able to get away from buying Twitter. But downside projections have been anywhere from $11-$35 were to Twitter trade without the deal. Some have said even if Twitter wins Musk may not pay. Like that comment, there is plenty of misinformation and extreme commentary regarding this merger.

Here are some Seeking Alpha articles on the subject if you wish to dig in further:

Is Tesla’s Elon Musk Above The Law? (NYSE:TWTR)

Twitter: The Risk Analysis Has Profoundly Changed

Twitter & Musk: Favorable Situation For Investors From Here On Out

Twitter: Why The Deal Financing Can Fall Through

Twitter merger possibilities

1. Chancellor McCormick rules in favor of Twitter and orders specific performance. Shareholders receive $54.20.
2. McCormick rules in favor of Musk. Twitter drops to a standalone price of $15-$20.
3. Neither side wants to chance a trial. Especially Musk if his attorneys convince him that he’s unlikely to prevail. So the sides agree to a reduced price. Perhaps $50.
4. McCormick rules in favor of Twitter and awards them financial damages. Perhaps $10 billion or approximately $12 per share.

However, after the first hearing, possibility number four seems to be less likely than has been speculated.

It is not at all apparent that damages could constitute a sufficient remedy to Twitter-Chancellor McCormick

Twitter merger probabilities

Specific Performance ($54.20)	40%
Musk wins in court	5%
Price cut	40%
Financial Damages	15%

Author’s projections

So since I think the odds are high that Twitter wins in some fashion, I looked for a trade that would match my projected scenario.

My Trade

Sell	5	Jan 20 Puts	$1.27	$635
Sell	4	March 55 Calls	$.55	$220
Buy	1	June 40 Calls	$7.60	($760)

How the Trade does at different scenarios/prices

1. Specific performance-$54.20. The June 40 Call is worth $14.20. The Jan 20 Puts and March 55 Calls expire worthless. The trade which not only cost nothing but put a premium of $95 in my pocket is now worth $1,420, making the total gain $1,495.
2. McCormick rules in favor of Musk. Twitter drops to a standalone ballpark price of $17. The June call is almost worthless. There would be half a year or more of time left so a new bull market or another takeover could result in some value to the call but unlikely. The March 55 Call would essentially expire worthless. The Jan 20 Put would be put to me so I would own 500 shares of stock at $20. If Twitter trades to $17 there would be a paper loss of $1,500.
3. Price cut-$50. Even with Twitter’s brutal earnings it is hard for me to imagine that they accept a price below $50. The June 40 Call would be worth $10. The Jan 20 Puts and March 55 Calls expire worthless. The gain would be $1,095.
4. McCormick rules in favor of Twitter and awards them financial damages. Perhaps $10 billion or approximately $12 per share. If Twitter’s standalone value is $17 per share, then the stock would trade around $39, maybe a little lower. The June 40 Call would be just out of the money but would have seven months or so of time value remaining. It could be worth $4 per share or so. The Jan 20 Puts would be way out of the money with only two or three months left and could be worth $.40. The March 55 Call also would be out of the money and could trade at $1. Ballpark total price would be a loss of $200.

Risks of selling options

Since the trade includes selling naked options, I would like to detail the risks for those who aren’t experienced with options.

The five January 20 puts that were sold would require the seller of the puts to purchase 500 shares of Twitter if the stock is below 20 at the close of trading the third Friday in January.

The four March 55 calls would require the seller of those calls to sell 400 shares of Twitter if the stock is trading above 55 at the close of trading the third Friday in March. In that case it would result in a short position.

Conclusion

Twitter’s stock is a hot topic these days. It has everything. A binary outcome, an upcoming court case, the richest person in the world and analysts and funds who seem to flip their opinions and predictions fairly often. But for me I focus on the contract and the law. By using options while carefully choosing the right series’ and strikes one can set up a trade based on probabilities. I have done that this past week in the same ratio under the ‘My Trade’ chart. I am willing to buy Twitter at $20 and sell it at $55 and I like the leverage and the significant time of the 40 Calls. All in all, the trade was for a small credit and is a wager on the Twitter saga ending with either specific performance or a small price cut.