Twitter: Play The Musk Walk With Options (NYSE:TWTR)

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Markets are hopeful that Elon Musk’s proposed $44 billion deal for Twitter (NYSE:TWTR) will be completed after a private meeting with the company. I am looking at a potential walk away from Musk and investors could play that outcome in the options market.

Twitter has a bearish technical setup

The technical setup in Twitter saw a bearish monthly close with a bearish candle engulfing the previous month’s rally. With that setup complete, it is possible that a move lower is coming.

TWTR

TWTR (M) (TradingView)

I also use a proprietary market timing model and I see the potential for a low or turning point in December. That means that the monthly low or a bullish rally from a bottom could happen there.

Musk has a win-win outlook for Twitter

The market was hopeful that the Twitter deal would pass after the company’s executives gave ‘unanimous approval‘ to the takeover. Shareholders still have to approve the deal, but it is expected in the coming months.

Twitter’s board stated in a regulatory filing this week that it “unanimously recommends that you (Twitter stock owners) vote FOR the adoption of the merger agreement” at Musk’s proposed $54.20 per share. The fact that the company is only trading at $39 shows that there is still some skepticism, but the recent stock market woes have not helped.

The Musk takeover deal has a deadline of October 24th so that lines up well with my end-of-year target. In an address to the company’s employees, he also stated that there may be cutbacks. Musk called for “some rationalization of headcount and expenses.”

“Right now, the costs exceed the revenue,’ he said, adding ‘anyone who’s … a significant contributor should have nothing to worry about,” he added.

So, Elon Musk is telling us that if his deal does not go through, the company is bloated and needs to trim staff and expenses to become profitable. That can add further downside to the stock if the deal goes through. I believe that the current deal outlook is a win-win for Musk. If his concerns about bots and fake accounts are proved to be right, then the company’s stock would take a hit and the deal could fail. That would leave Twitter in a position where it would have to accept a lower offer for the company. That may not be easy to stomach for investors, but the stock would be revalued accordingly. Elon Musk has said that he has three concerns over the current deal that need to be resolved.

One of those is the issue with spam accounts on the platform. Twitter says that the account is less than five percent of its “monetizable” daily active users. But Musk said that the figure is “probably not most people’s experience when using Twitter.”

The second issue is on his end with debt financing. Musk has promised to lay down $33.5 billion in cash and has secured another $7.1 billion in commitments from outside investors. That should be easy to secure the final $3-4 billion and is not an obstacle. The final issue is the shareholder vote and the board’s recent approval of the deal should convince shareholders that it is a fair offer.

So here is the kicker. The only reason that Elon Musk asked for the data on bot accounts and spam is that he obviously did some research ahead of time and likely found a more realistic number that is above 5% of daily users. Despite the threat of a $1 billion fee if he walks away from the deal, Musk’s lawyers said in a previous SEC filing that Twitter was “actively resisting and thwarting his information rights” by not sharing data.

“This is a clear material breach of Twitter’s obligations under the merger agreement and Mr. Musk reserves all rights resulting therefrom, including his right not to consummate the transaction and his right to terminate the merger agreement,” his lawyers said.

So, why did Twitter hold back on the data in the first place? The situation is a win-win for Elon Musk. If he walks away from the deal, even with a $1bn hit, the company’s stock could crater under the loss of the deal, the reality that advertisers could bring lawsuits if the company lied about the number of ‘monetizable’ accounts, and the fact that the company needs cuts in expenses and staff.

Musk could then buy up another batch of shares in the open market and consider his options for a cheaper takeover offer. The risk/reward for investors is a $15.00 gain or a potentially bigger loss. Even at 1:1, that means that the downside risk does not warrant a stock purchase at $39.20.

Playing options could be the value play in Twitter

Investors looking to capitalize on this play will see value in the options market. Twitter currently trades at the $39 level, but the first supports ahead of $30 would go easily in the event of a negative outlook for the deal. The next supports that would come into play are ahead of the $20 mark.

Twitter Options

TWTR Options (Dec) (Yahoo Finance)

The value in Twitter options, therefore, would be in the $25.00 or $20.00 put option strikes for the December 16th expiry. I would look for a stake in the 25s with a target of $20 in the stock. That gives a potential return of almost 5X if the target is hit. Investors could also take some 20 strikes in the event the market goes back to the support at $15.00. That would also provide investors with some downside protection from an extension of the technology sell-off.

Conclusion

Elon Musk is thought to be closer to a deal for Twitter after receiving more data from the company on fake accounts and bots. The Tesla founder has already said that expenses and staff need to be cut and walking away from the deal could hurt Twitter shares. The financing part will be easy, and the company’s board has signaled to shareholders that the deal is fair. The sticking point is the data on the company’s bot accounts. If Musk can accuse the company of misrepresenting the number of fake accounts, then the stock could be in trouble. The value on a risk/reward basis is on the short side and we also have a bearish pattern in the monthly chart. I would suggest put options with a December strike in TWTR and watch the events unfold.

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