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Forget the stock—the smarter way to play Twitter

Tuesday, 12 Nov 2013 | 7:00 AM ET
A trader watches Twitter stock at the closing bell the day of its IPO.
Adam Jeffery | CNBC
A trader watches Twitter stock at the closing bell the day of its IPO.

Twitter came public on Thursday, stoking a great deal of interest and a busting out of the gate with 73 percent rally off of its IPO price. But while investors finally have a chance to own a piece of the social network, some traders say the better way to play Twitter will be by using options, which will be listed on Friday.

Options provide the ability to make bullish or bearish bets on shares of a stock without outright owning or shorting the stock. And in the case of Twitter, some traders say that might be a great call.

"My feeling is that it will trade lower here in some form of another, but I wouldn't try to short this thing," said Brian Stutland of the Stutland Volatility Group. Because he doesn't know how high the stock could go, he said, "I always like using options to control that risk."

In fact, if shorting the stock proves difficult, then using options to express a bearish view could be more than preferable—it might be all but necessary.

"If someone want to sell Twitter shares short, they would first have to borrow them," pointed out Scott Nations of NationsShares. "With a small float, dedicated insiders, and IPO managers interested in thwarting short sellers, it's going to be difficult to borrow shares. That means that for most traders, the only way to express a bearish opinion on Twitter is to use options."

But this brings up a separate set of issues that make Mike Khouw of DASH Financial hesitant about using a bearish options strategy. He points out than when a stock is difficult to short, then the high price of borrowing it gets reflected in the bearish put options.

Twitter trading on leap of faith: Pro
Michael Patcher of Wedbush Securities explains why he is cautious about Twitter at current buying levels.

"If the stock is hard to borrow and people choose to use puts, then they're going to be paying a lot for those puts," Khouw said.

A second problem is that traders will probably expect the stock to move around a great deal, as it already has—it hit a high of $50.09 and a low of $39.40 in its first three days of trading. That means options sellers will demand compensation from options buyers for the risk.

"Puts are going to be expensive because of implied volatility, and if the stock is hard to borrow, then puts will be expensive because of that too," he told CNBC.com.

Indeed, after modeling likely prices, Khouw concluded that with shares at $43, a 40-strike put expiring in 90 days could cost about $5.30.

"You're going to need to see the stock decline by 20 percent," he said. "I don't think racing out to buy puts is going to be a good bet."

But if one must express a bearish view, then perhaps paying too much for puts is still preferable to shorting the stock outright—given that getting short technically exposes one to the potential of infinite losses.

"Options are definitely a better way to play it," Stutland said.

—By CNBC's Alex Rosenberg. Follow him on Twitter: @C NBCAlex.

Follow "Options Action" on Twitter: @CNBCOptions.

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