Possibility to play on Twitter | Looking for Alpha
Musk is a man of his word. He promised to pay a 20% bonus for Twitter, Inc. (NYSE: TWTR) on April 13, and he did as the board had agreed to his terms.
Musk paid for the company like this was a private equity transaction. Musk’s price is 68% above the low set in early March, and that’s about the same as the average premiums paid in private equity deals in 2021.
While shareholders got a good deal, holders of convertible debt did not. Twitter converts are trading at $123/share upon conversion for the 2026 expiry and $62.2/share upon conversion for the 2024 expiry.
Callable bonds, however, have a clause attached that in the event of a takeover or change of control, the parties involved must redeem the bonds at 101 cents on the dollar.
Above all, Musk was enjoying himself as the happiest shareholder. The cost of his own stake in Twitter is estimated at $36/share, currently valued at $3.34 billion. Musk pays himself a 50% premium to acquire the company.
Now that the deal is subject to Twitter shareholder approval and the reverse break fee is included, the financing of the deal – $25.5 billion in fully committed debt and margin loans and 21, 0 billion dollars in equity – can exceed shares of Twitter and Tesla (TSLA).
Call options on Twitter traded at a 2.5-to-1 volume ratio to put options, likely when short option positions were closed. The put-call open interest ratio for the stock is at a 2016 high (Figure 1)
Figure 1: Open interest in put-calls on Twitter
Call option volumes peaked as Musk’s buyout bonus was priced into calls (Figure 2).
Options show significant trading activity for calls at $55/share and puts at $45/share for the highest volumes of 30,000-50,000 contracts. The options market treated Musk’s deal as a chokehold; an indication that the stock could trade in the $45-$55/share range over the next few months until the deal is finalized.
Shareholders may view Musk’s deal as the best they can get given the lack of interest from bidders and the board agreed not to include a “go shopping” clause. Holding the stock has little benefit ($4.20/share over the current price) because the stock is less likely to trade above the tender offer unless a new bidder emerges at the last minute.
The stock’s decline is also somewhat limited, although subject to broader market changes. The lower end of the range at $45/share is where the stock was trading when Musk made the offer. The options market set a range for the stock, capping the upside below the offer price and capping the downside at the price at the time the offer was made.
Now that it is certain that the deal is done, it is possible to sell a choke with strikes at 55 calls and 45 puts for the June expiry.
Figure 2: Volume of call options on Twitter
Musk’s buyout price may keep calls at $55/share in demand. Put options at $45/share will also remain in high demand as there remains a risk that the deal could fall apart.
The short strangle gain shows a stable and positive premium up to $55/share. Beyond that price, there is a loss in case another party outbids Musk’s offer. The new bid price would set the call option strike price at a higher level of volatility. Below $45/share, there is a risk that the deal will fail, although that may happen at a lower price (Figure 3).
Still, Musk’s ability to get the board to agree to his terms makes the deal likely to go through. The stock’s implied volatility fell sharply after the announcement of the deal and could fall further. In a declining volatility environment where stocks remain rangebound, the perceived premium of short strangleholds is $2 per option contract.
Musk got shareholders a good deal, and the options market may give investors a premium for generating additional revenue.
Figure 3: Twitter strangles the strikes earnings chart from $55 to $45