KMG Put fun

Discussion in 'Options' started by stock777, Apr 20, 2005.

  1. Anyone want to do an analysis of the KMG options skew. It's because of a tender, but would like to see a walkthrough of why the prices are like this. Good excercise.
  2. Anseld


    the tender offer takes some away from the float and reduces availability of shares to short, which makes the stock difficult to borrow. people getting bought in might not want to give up their position, but since they can't complete it with the common, they bid up the puts and use synthetics to substitute. marketmakers selling the puts may have trouble with stock accessibility as well, so their offers for the puts carry higher implieds, especially the deep ones. their own bids have to be marked down though. the pricings of the calls are brought down because they are priced for early exercise. the marketmakers don't really want them neither because of limited shares. most of their bids are below water as they get in the money. they want the public to take them and discourage them from selling the calls. if they buy them, they will quickly exercise them and sell the shares for wash. but since there's really no extrinsic value of the calls, they don't lose anything since they are priced with little or no premium. there are interesting ways to play this, but it depends on how patient you are and what you want to take in. the kmg tender offer is between $85-$92, so there are a few key strike levels to look at.
  3. So are the puts good to buy??
  4. Anseld


    if you want to play the arb, no. at least not the jacked up ones.
  5. Anseld,


    I read that three times and still had trouble following it...complicated stuff.

    My take on this situation is the tender (for a bit more than 1/4 of total shares) will be pro rata if oversubscribed -- which at this point looks likely. This has the following implications.

    Given the current stock price of 79ish that means the company is offering -- today -- a minimum $6 premium for those shares which actually are accepted. However, that also means that the company is actually decreasing the remaining shareholder's value by $6 x 1/4 total shares -- i.e. dilution -- relative to today's price. So the net effect on the stock if all things are equal is that the price should decline a couple of bucks from this price on the day of the tender.

    I thought that the dilution was what was being priced into the puts as an additional premium...

    If my logic is wrong I'd appreciate it if someone would correct me. And I am not suggesting that what Anseld said doesn't apply either -- especially since I don't full understand it. :)


  6. Anseld


    hi sam,

    oh, my response was geared more towards the "hard-to-borrow" aspects and the effects on the option market when a tender offer occurs. as you know, currently, there is at least a $6 premium for the shares that will be taken in, but the premium on the puts should still exist even if that $6 gap suddenly thinned to nothing. for the most part, the general mispricing has a lot to do with the availability of the float (low). some strike levels are priced according to speculative play, but if you look at every series, most of the options are pretty much evened out on the synthetic level, although it's done at a discount relative to the common. the value of the puts are inflated to accomodate the lack of accessibility to short in the market. and if you look at the adjacent calls, especially the deep ones, they are priced for early exercise because they are risky to hold. marketmakers want to short them instead, even if it's only temporarily, so some of the bids might not even be priced at what is deserved by the intrinsic.

  7. You lost me. I don't see any particular skew on the ditm calls. And why would they be risky to hold long?

    I tested the stock for shortability at one broker and they had it, what makes you think it's hard to borrow?

    imo, though it's a bit too convoluted for my every fading iq, this skew has something to do with the arbs hedging thier positions against partial allocation.

    PS. Be careful with your fair value models on this, they also announced that the div was being cut from 1.80 a year to 20 cents.

    This is not reflected in some models I looked at since it's not 'official'.

    They like to keep you on your toes, don't they.
  8. The company is also reporting earnings next week. While this should not effect the value of the tender -- would it get less oversubscribed in the event of bad results? -- it could easily impact the stock price.

    So, if there is a skew it could also be related to estimating earnings risk as part of a tendering model....just throwing something out here to see if it will fly. :)
  9. Anseld


    what you have on the ditm calls from the bids are option values that are less than what is given by the intrinsic. you should see a huge put/call disparity on almost any level, near-term or far-term. the synthetics don't match the relative common, and the calls create that effect as well as the puts. the deeps calls are risky to hold because of possible subsequent buy-ins, so they are priced for early exercise to eliminate that holding risk. kmg is about to absorb 25% of the float, so there is high probability that existing shorts may have trouble maintaining their position. it may not be fully hard to borrow yet because the deal hasn't been fully consumated yet. but hard-to-borrow status is more of a "future status" concern than "current status" concern, so if your broker says it's currently a pretty easy short, they could be right, but that's only for today or this week but not necessarily for the future when a chunk of the float is taken out of the market.

    here's a random company (never heard of them) that has kmg on the "hard-to-borrow" list already. type in kmg in here:

    this is an 'easy-to-borrow' list from another firm (not mine), and anything not listed is usually considered 'hard to borrow'. kmg isn't listed.

    of course, every broker/house has varying levels of access to different things for different customers, but at the end, once everything is done, kmg shares should be somewhat harder to short in the future than how it might be today or how it was last month. the tender offer affects aggregate liquidity. plus, you got that regulation sho issue.
  10. Best case scenario looks like this:

    30% of shares tendered are worth $92.
    70%(what is not accepted ) become new KMG with decreased dividend and higher debt load, high end $73.

    Implied forward value of KMG stock = 78.70.

    It looked like conversion trading about 2.50 over.

    Buy stock 78.70. Sell may 80 call 1.60 buy may 80 put 5.40.

    Puts trade to parity, 0 calls assigned, you break even if stock opens 73.

    I guess to make money you hope some 80call are exersised and you can sellyour remaining synthetic call over parity.
    #10     Apr 24, 2005