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Hedging against volatility in Twitter stock is pricier

February 5, 2014 By Lee Ways

Twitter Inc. (NYSE:TWTR) has become the most expensive stock in terms of hedging against volatility second only to Ariad Pharmaceuticals (according to Bloomberg) among the companies which form the Russell 1000 index. This follows the first earnings report from the company after it went public and the more than doubling of the share price.

The implied volatility at 93.03 (as at 10 January 2014) which is used to establish the pricing of derivatives based on equities is triple the average of the stocks In the index. Investors are hedging to protect themselves in case growth in revenues or the number of users does not justify the present high valuation.

It is presently valued at just under 29 times the expected sales for 2014 compared to the largest social network Facebook which is valued at 14.2 times and 12.1 times for LinkedIn estimates Bloomberg and the company is not expected to be profitable until the year 2015. It will report its next quarterly results on February 5. According to consensus estimates from analysts, the fourth quarter should show revenues of $217 million up almost 100% year on year and operating losses of $20.6 million. The company has been beefing up its advertising offerings especially for mobile devices to enable advertisers to reach out to its user base of more than 230 million accounts. Ever since the IPO, the company has completed the integration of an acquisition which will boost mobile advertising and reinforced keyword and audience targeting strategies.

Investor sentiment has shifted and concerns about valuation by leading investors to use options to protect themselves or to short the stock outright. Goldman Sachs has raised the target price from $46 to $65 citing significantly accelerated innovation along with a buy recommendation. However, in recent weeks, analysts such as Morgan Stanley have downgraded the stock causing it to lose around 10% since the beginning of the year. Analysts ratings show 11 sell recommendations, 6 buy recommendations and 11 hold recommendations. In contrast, there are no sell recommendations for Google and LinkedIn. The implied volatility on 30 day options have risen by more than 140% to a record figure of 102.44 compared to 52.42 for Facebook, 27.99 for the Global X Social Media Index ETF and 26.35 on average for the Russell 1000 index.

Investors looking to trade on the growth prospects of Internet and social media companies are increasingly turning to equity derivatives and, for instance, as of 10 January, there was an open interest of 3.93 million on Facebook options, the highest among companies traded in the US after Bank of America and Micron Technology. Twitter contracts came to 1.27 million ranking it among the highest on US stock exchanges. In addition, bets against the stock in terms of stocks borrowed for shorting accounted for a record total of 35% of the total trading. Some analysts believe that there are exciting possibilities for the stock because of the momentum that is built up and the demand and supply situation. Investors seeking protection have pushed up the prices on more bearish options compared to the more bullish ones and put options for a 10% drop in price are priced at 1.92 points more than call options on a 10% increase. This is a change from the position two weeks ago when the spread was -1.2 points.

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Filed Under: Twitter News

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