Twitter’s Ups and Downs Make Hedging Costly for InvestorsNikolaj Gammeltoft and Sarah Frier
Twitter Inc.’s first earnings report and a 119 percent surge in the shares has made the cost of protecting against volatility higher than all but one of the companies in the Russell 1000 Index.
Implied volatility, the proxy for future share movement used to price equity derivatives, was 93.03 on Jan. 10, triple the average for stocks in the Russell 1000. Only Ariad Pharmaceuticals Inc. was higher, according to data compiled by Bloomberg on 30-day contracts closest to the shares.
Doubts about whether Twitter can deliver enough revenue or user growth to justify its valuation are leading investors to hedge the stock’s gain, according to Kurt Ayling, a technology, media and telecom desk analyst at Susquehanna Financial Group LLLP. The company, which reports quarterly results on Feb. 5, has a higher valuation based on expected sales than any of its peers, including social-networking sites Facebook Inc. and LinkedIn Corp.
“There’s a lot of uncertainty around the stock so people are, for the most part, using options to hedge or outright short the stock,” Ayling said in an interview. New York-based Susquehanna beneficially owns 1 percent or more of Twitter securities and is also market maker in them. “Sentiment around the stock has changed a lot at the start of this year as people quickly shifted gears, and all of a sudden valuation concerns became a major part of the story.”
Twitter shares climbed 1.4 percent to $57.82 today after analysts at Goldman Sachs Group Inc. raised their share-price target to $65 from $46. There was a “significant acceleration” in innovation during the fourth quarter, wrote Heath Terry, an analyst at Goldman Sachs who recommends buying the shares.
Morgan Stanley and at least five other analysts have downgraded San Francisco-based Twitter in recent weeks, causing the stock to slip 10 percent since the start of the year. The company has the equivalent of 11 sell ratings, 11 holds and six buys from analysts, according to data compiled by Bloomberg. Facebook, Google Inc. and LinkedIn have no sell ratings.
Twitter is projected to nearly double sales to $217 million in the fourth quarter, with an operating loss of $20.6 million excluding some items, according to the average estimate of analysts surveyed by Bloomberg. The stock has risen to $57, compared with its initial public offering price of $26 in November.
Twitter, which allows users to post 140-character updates to their friends and followers, is valued at 28.9 times expected 2014 sales, compared with 14.2 for Facebook, owner of the world’s largest social network, and 12.1 for LinkedIn, according to estimates compiled by Bloomberg. Twitter has one-fifth the users of Facebook and is not expected to be profitable until 2015.
The shares have gone “too far, too fast,” Ben Schachter, an analyst at Macquarie Securities in New York, wrote in a Dec. 27 report. “As a stock, we believe nothing has changed over the last 15 days to justify the rise in valuation.”
The implied volatility on Twitter’s one-month options closest to the stock price rose 147 percent in the past month to reach a record of 102.44 on Jan. 6. That compares with 52.42 for Facebook and 27.99 for the Global X Social Media Index exchange-traded fund. Companies in the Russell 1000 have an implied volatility of 26.35 on average, data compiled by Bloomberg show.
Jim Prosser, a spokesman for Twitter, declined to comment on the options trading.
Equity derivatives on social media and Internet companies are among the most popular with investors looking to speculate on their growth potential. Facebook options had an open interest of 3.93 million as of Jan. 10, the third-highest among U.S.- traded companies after Bank of America Corp. and Micron Technology Inc. Ownership of Twitter contracts was 1.27 million, also among the highest on U.S. exchanges.
Wagers against the stock have increased, with the number of shares borrowed and sold short accounting for a record 35 percent of the total available for trading on Jan. 2, according to Markit, a London-based provider of financial information services.
Twitter has been updating its advertising products to help brands reach its more than 230 million users, especially on mobile devices. The company, whose service acts as a global megaphone for celebrities, politicians, individuals and more, went public on Nov. 6. with promises of fast growth.
“The opportunities with Twitter are huge,” Rob Sanderson, an analyst who has a buy rating on the stock at Stamford, Connecticut-based MKM Partners LLC, said in a phone interview. “This is a momentum stock, and there’s a supply and demand issue. There aren’t a lot of exciting growth areas that have this open-ended nature.”
In the weeks since the IPO, Twitter has enhanced keyword and audience targeting and integrated an acquisition that will help with advertising on other mobile applications, boosting the stock price.
The Chicago Board Options Exchange NDX Volatility Index, which tracks the cost of 30-day Nasdaq 100 Index options, added 6.8 percent to 15.05 after falling 11 percent last week. The CBOE Volatility Index of S&P 500 options prices gained 9.4 percent to 13.28 after slipping 12 percent in the previous week.
Traders have pushed up the price of bearish options on Twitter relative to bullish ones. Puts protecting against a 10 percent drop in the stock cost 1.92 points more than calls betting on a 10 percent rally. That’s up from a spread of minus 1.2 for the price relationship known as skew two weeks ago, according to three-month data compiled by Bloomberg.
“While historically we’ve reserved our sell rating to business models with structural challenges, we find Twitter’s valuation to be excessive and currently see materially more downside than upside,” Youssef Squali, an analyst at New York-based Cantor Fitzgerald LP, wrote in a report to clients that cut the stock’s rating to sell from hold on Jan. 8.