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A festive trade: The Christmas tree explained

The holiday cheer isn't spreading to Twitter shareholders.

The social media giant fell 3 percent Monday to its second-lowest intraday level ever as continued concerns over the company's slowing user growth has investors hitting the sell button. For those looking to profit from the stock's decline, one trader outlined a very festive options strategy.

On CNBC's "Options Action" Friday, Michael Khouw explained a rather unusual trade structure called a put Christmas tree. In this strategy, a trader will buy a put, sell a lower strike put and then sell another low strike put all of the same expiration. Options traders typically assess the payout structure by using a graph comparing the stock price to profit or loss. On such a chart this particular trade looks like a Christmas tree.

The trade Khouw suggested for Twitter was the March 22/20/18 put Christmas tree for zero cost. In this trade, Khouw is willing to get long the stock if it falls as low as $18, but he sees profits if the stock is anywhere from $16 to $22 by March expiration. That's nearly 30 percent lower than its current price of around $22.50.


Read MoreOptions Action 101: How options really work

For Khouw, there are three key things one must consider when implementing this type of structure, "A Christmas tree is a trade that you want to do when volatility is fairly high," said Khouw. "It's also a trade you would typically employ if you don't have a tremendous conviction on the direction of a stock," he added. "It's also a trade you might do if you are willing to buy the stock at a much lower level than where it is trading or potentially sell it at a much higher one."

"Volatility is exceptionally high in Twitter, and it would be very hard to catch the falling knife," the co-founder of Optimize Advisors said. Twitter shares have fallen more than 37 percent in 2015.

According to Khouw, if the stock were to fall as low as $16 it would put a $9 billion valuation on the company, excluding the $1.9 billion they have in cash. "I have to think that at single billion dollar valuations Twitter starts looking attractive — maybe to a buyer or an activist," Khouw added. "This remains a really unique social media property.

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  • Melissa Lee

    Melissa Lee is the host of CNBC's “Fast Money” and “Options Action.”

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