Volume 8, Issue 13
Takeover File
Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
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Since we know that takeovers usually create uncertainty, which often leads to higher options prices, we are going to begin updating the takeover file. We plan to briefly review a few of the active takeovers from an options volatility perspective and then make a few suggestions. We are planning to make the “Takeover File” a regular featured section of the IVolatility Trading Digest™ and will try to offer a few ideas and suggestions in each future issue.
Market Review
The CBOE Volatility Index (VIX) 25.71 has returned to the 25 level but remains like a compressed spring ready to jump up again to 35 on short notice. We think it may have its chance once again when the quarterly earnings announcements get underway shortly.
The US Dollar Index (DX) 71.68 made a brief trip to 73 and then quickly returned once again to the 71 level. This brief counter-trend rally was just enough to knock the legs from under the commodity group. As we have suggested many times watch this index as one of the key indicators for the commodity related groups.
Our favorite market breadth indicator, the NYSE McClellan Summation Index improved 116.63 points in the past week and now reads –511.17. We are expecting to see a Summation Index reading near
–750 before the equity market finally bottoms.
Strategy
With a US reflation underway and global inflation numbers now running near 5% with negative real interest rates it is hard to imagine how the dollar with find much support at this level. As a result we think the commodity groups will continue higher. Look for opportunities in gold and silver producers, iron ore and copper producers as well as other equity opportunities in the commodity export producing counties, such as Brazil and Russia.
IVOLopps™ Takeover File
At the top of the list in the takeover file is the controversial Bear Stearns deal.
The Bear Stearns Companies, Inc. (BSC) 10.78. BSC operates as an investment bank, securities and derivatives trading and clearing brokerage. Bear vertically integrated the mortgage market from origination to the ultimate sale of mortgage back securities.
In IVolatility Trading Digest™ Volume 8, Issue 12, Spring Potpourri, dated March 24, 2008, we suggested an aptly named bear put spread for Bear. We got this one wrong by a multiple of almost five. We did not think a higher offer would be on the table, but this proved not to be the case. Since the revised offer was made before the market opened on the March 24, 2008 the implausibility of our suggestion would have been obvious.
The revised JP Morgan offer, intended or not, was a brilliant negotiation strategy execution. First they offered a price that represented an almost total loss for the equity holders. Then when facing the real prospect of such a loss James Cayne, Bear’s Chairman quickly took the opportunity to sell his entire personal stake in the market at just above the revised offer price, representing just one-third of its value just two weeks prior. It now seems as if they will be no serious challenge as the revised JP Morgan offer also included their purchase of new stock to be issued representing a 39.5% stake giving them even more voting power to influence the outcome.
At the risk of getting it wrong again we are going to make another suggestion to participate in this high stakes drama. With and irrelevant Historical Volatility of 599.82 consider this put sale.
- Sell BSC Apr 10 put BVDPZ .565 IV 77.93 Delta .3675
Since JP Morgan plans to buy the stock at 10, the risk here is an upset, which seems unlikely, but nevertheless possible. As a practical matter it would be difficult to establish a stop level if an upset were to occur and the same prospect facing shareholders last week would return for the short put holders. The best risk management strategy is to limit the position size.
Clear Channel Communications Inc. (CCU) 29.20. San Antonio based CCU is a media company operating in the more traditional format of radio and television advertising along with outdoor displays. The company is involved in a private equity buyout that ran into funding issues with their banks who refused to honor the original terms of the financing after the credit market conditions changed. This long delayed deal made news as a Texas Judge awarded Clear Channel an order restraining the banks from interfering with the merger by refusing funding according to the original commitment letter. Unless the banks appeal, which they may, this deal will now move forward. With a Historical Volatility of 93.09 consider this put sale in a Type II volatility pattern (high with both implied and historical expected to decline).
DR: This deal is now likely to close. The put strike price is below the recent low before the legal ruling.
SU: If assigned stock because it closes below the strike price then sell the stock at 24.40, the break-even price (strike price less the premium received).
- Sell CCU Apr 25 put CCUPE .60 IV 78.05 Delta at .1800
Srius Satellite Radio Inc. (SIRI) 2.80. We return once again to the long delayed merger between Sirius Satellite and XM Satellite Radio Inc. The US Justice Department has cleared the proposed merger saying it would be unlikely to harm consumers. Next the Federal Communication Commission must also agree while the traditional broadcasters are applying intense political pressure in an effort to scuttle this deal. Apparently they think satellite radio will go away and will not be a future competitive threat if this merger fails. We think the tactics and motives of the traditional broadcasters are obvious to all and common sense is likely to prevail. Further, we understand the FCC usually follows the Justice Department recommendations. With a current Historical Volatility of 50.60 consider this put sale.
DR: This deal is now likely to close with conditional FCC approval.
SU: Caution is advised, as a stop loss sale would be difficult in the event the approval is rejected. The only real effective risk management tool is size limitation.
- Sell SIRI Jun 3 put QXORG .675 IV 104.95 Delta .4501
With a nice positive volatility spread the downside risk could be a stock price near zero if the approval is denied.
In IVolatility Trading Digest™ Volume 8, Issue 12, Spring Potpourri, dated March 24, 2008, we suggested considering the sale of the April 27 ½ call against the previously established long synthetic. Long the Jul 27 ½ call and short the Jul 27 ½ put.
Yahoo! Inc. (YHOO) 28.99. For the Takeover File we return again with another suggestion. With a current Historical Volatility of 35.65 consider this put sale.
- Sell YHOO Apr 27 ½ put YHQPY .905 IV 56.17 Delta .3220
With a good positive volatility spread use the break-even price of 26.595 as the stop.
Legally Induced Volatility
Another cause of uncertainty and hence increased Historical and Implied Volatility is legal activity. It is in this category that we found our next suggestion.
Tessera Technologies Inc. (TSRA) 21.93. San Jose, California based TSRA develops and licenses miniaturization technologies for the electronics industry. It engages in licensing technologies for chip-scale, multi-chip, and wafer-level packaging, and micro-optics solutions for miniaturization in electronic products.
On Friday TSRA was at the top of the percent gainers list with a 5.44 point, 32.99% gain with almost 11 million shares traded. There were 16,840 options traded placing it about halfway down the Top 200 Options Volume list just between Boeing and KB Home.
TSRA is in a legal battle with Motorola, Freescale, Qualcomm and others over wireless patents. The US International Trade Commission has issued a notice of unanimous Order denying a stay in the case saying that the previously dismissed case shall be reinstated at “the earliest practicable time”. With this ruling TSRA now thinks the matter is back on track for a prompt resolution.
Prior to the first unfavorable order issued by an Administrative Law Judge on February 26, 2008 TSRA was trading at 40. Now at just under 22 it could very well continue recovering back to the 40 level.
The put/call ratio is on the extreme bullish side with a reading of just .4 and with a current somewhat irrelevant Historical Volatility of 221.49 considers these ideas. Both volatility measures are in a Type II pattern (high with both implied and historical expected to decline). As would be expected the implied volatility is now rapidly declining.
- Sell TSRA Apr 20 put TJQPD 1.375 IV 107.10 Delta .3129
Or perhaps this safer and somewhat higher priced alternative.
- Sell TSRA Apr 17 ½ put TJQPW .675 IV 116.46 Delta .1739
A quick price reversal and a close below 15 would be the signal to reevaluate and perhaps close the trades. The risk is legal and usually difficult to evaluate as it is in this case.
Previous Issues and Reader Response Request
All previous issues of the Digest can be found by using the small calendar at the top right of the first page of any Digest Issue. Click on any underlined date to see the selected issue. As usual we encourage you to let us know what you think about how we are doing and what you would like to see in future issues. Send us your questions or comments, or if you would like for us to take a look at a specific stock or ETF just let us know. Use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.
Posted by Carl on April 02, 2008 at 11:03 PM EST
Posted by Jacktrader (66.182.123.195) on April 03, 2008 at 01:03 AM EST