BARE - How Pros Trade Takeovers

Discussion in 'Trading' started by livevol_ophir, Jan 21, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    BARE is trading 18.11.

    The company is in a deal to be taken over for $18.20 in cash. The Corporate Action Pop-up is included in the article.

    The company has traded over 20,000 options today (not a typo) in the first 2 hours on total daily average option volume of 893. The Company Tab snapshot is in the article.

    Essentially the entire volume was a 20,000 lot purchase of Jun 17.5 calls. The options traded with 1.4 million shares (sold) @ 18.10. The day's biggest trades and Option Tab snapshots are inlcuded in the article.

    The calls traded with stock on an implied 70 delta (1.4million/2 million). That means the trade is really 70 puts for every 30 calls.

    The puts have an implied price of:
    Puts = calls - parity - cost of carry
    = 0.85 - (18.10 -17.5) - .04
    Puts = 0.21

    That's 0.85 + 0.21 = 1.06 in 30 straddles and 40 more puts for 0.21. The payoff diagram for the trade at Jun expiration is included in the article.

    Max loss is at 17.50 - but analytically, that outcome seems very unlikely. i.e. Either the deal closes for $18.20 or the stock falls hard on a bust. The stock was trading ~13.00 before the announcement.

    <b>Stock</b>
    $17.50: -$860,000 (max loss)
    $13.00: +$5,400,000
    $18.20: -440,000 (deal price)

    So this is a $440,000 loser if the deal goes through with an upside of $5.4 million if the deal falls apart and the stock goes back to the original price. That's a 12.3 to 1 payoff. These are exactly the types of trades pros make on takeovers - "cheap bets" (in this case 0.21 options) to make huge money (in this case $5.4 million).

    If you do an odds analysis (outcome tree) - you can create your own probabilities that the deal does/does not go through and try to position yourself accordingly. Remember a bet that is wrong 90% of the time is a good bet if it pays off more than 10:1. Alternatively, a bet that is right 90% of the time is a bad one if the payoff is worse than 1:10.

    Play the odds, make appropriate bets with better payoffs than the odds, repeat --> Successful trader.

    This is trade analysis, not trade advice. I have no idea what the odds are of this deal going through.

    You can see details, prices, trades, charts here:
    http://livevol.blogspot.com/2010/01/bare-escentuals-bare-how-options-trade.html
     
  2. i think you are a great analyst and i enjoy all your posts. THANKS

    IMO, this particular deal will not fall through. The company was incorporated in 2004, IPO 2006.

    I feel the insiders are getting a huge windfall here and are happy to take the money and run. The stock has had a "nice" run since the low of $2.45 last year and at the pre announcement level of $12 was probably already overextended.

    BARE along with companies like TRLG sell and market a gimmick product in which success depends on sensitive consumer tastes and generational fads.
     
  3. livevol_ophir

    livevol_ophir ET Sponsor

    The options definitely imply this has a very low probability of happening - i.e. less than 1/12. You sound like you know a fair amount about this issue - I actually don't. If I was getting 1:1 payoff of course I would bet this deal happens. Actually, I would probably do that bet until my head caved in.

    With the payout 1:12, now I limit that bet if I make it all (or even consider the other side). Thanks for your feedback!