SII & SLB Takeover - How Options, Skews are Reacting

Discussion in 'Options' started by livevol_ophir, Feb 19, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    SII is trading 37.65 up 4.30 (12.9%) with vol up 5 points. SLB is trading 63.75, down 2.06.

    So a bid is "coming" from SLB. "The deal would create an industry giant with revenues double that of rival Halliburton Co.", The Wall Street Journal said. This has a few implications.

    (1) The short term downside for SII is much lower.
    (2) The short term upside for SII is in flux.
    (3) A deal this big has regulatory problems written all over it.

    Here's how the options show you the same things as above through the skew chart (included in the article).

    (1) The red line (March Options) has a weird downward bending skew - like a reverse parabola as you get to the OTM puts.
    (2) The red line on the upside has a distinct upward kink - expectations are for ~$9 billion bid ---> ~$41.10 in SII. But maybe it's higher (or lower)?
    (3) The vol is actually up today (see IV30™ in summary above) - this is far from a done deal.

    Also note the distinctly lower monthly vol as you go further out (overlaid from the Options Tab near the bottom of the skew chart). This occurs b/c there is a legitmate chance this deal does go through, and options become worth parity (i.e. zero vol).

    Options Tab snapshot is included (in the article). Note the action in the Mar 40 calls.

    I'm not allowed to offer trade advice in any way. If you want to trade this, consider these questions as a guide:
    (1) If there is regulatory approval required, how long does that usually take?
    (2) What are the chances of approval? Is there a similar attempted deal(s) to compare to?
    (3) Is there a potential for another bidder? You can read the blog on the AGU, CF, TRA saga (BLOG HERE) to see what happens when mulitple companies are involved. Typically prices rocket higher.
    (4) Is there a potential for a rejection from SII shareholders to the SLB bid?

    Taking these questions/answers - what is the fair price for the options in each month relative to each other? Setting a specific price can be hard (or impossible) - but comparing months to each other can be easier. Time spreads can be a great way to play these events - limited downside, beat the machines matching markets with each other with better analysis than a dopey quoting script. Then again - maybe they're right.

    The basic approach we use on the floor when we trade this type of event:
    (1) Create a few "likely" outcomes and assign stock prices to them
    (2) Assign dates to the possible outcomes
    (3) Assign probabilities to the above.
    (4) See if your prices match the market
    (5) Make cheap bets with big payoffs where you feel the probability distribuion is incorrectly priced.
    (6) MOST IMPORTANT: If there's no opportunity according to your analysis - walk away.

    This is trade analysis, not a recommendation.

    Details, prices, skews, vols here:
  2. Taking a look at your “guide” and answering those questions:
    (By the way you can offer all the trade advice you like it’s a public message board)
    1) Before they get this close to announcing the exact terms of the deal the lawyers for the IB whose doing the deal have already worked through most of the regulatory issues and have talked to the DOJ, and SEC.
    2) Generally the chances of approval are pretty darn good but the best way to get an idea is looking at how the risk arb desks price the deal. When the terms are announced the stock prices won’t go to the exact terms of the deal they’ll go pretty close but not there. What stops that is the risk arb guy’s assessment on whether or not the deal with finalize.
    3) Anyone’s guess but I would doubt it.
    4) Generally before they announce these deals they have the votes lined up. The “public” shares are for the most part not a factor so long as they have all the institutional holders lined up
    The time premium across the months becomes a moot variable once the dates are announce. Therefore, and I will just make up an example here. If ABC is going to acquire XYZ for 50 bucks a share, the deals announced and expected to go through on April 2nd. You’ll find that all the call’s over 50 in all months will be worth just about ZERO, all the in the money calls will be priced with almost no time premium even across the expiration months. That means the Dec 2010 50 calls which you own and paid 4 bucks for last week are going to trade basically for nothing since the deal will be done long before Dec and at a price of 50 bucks. The tricky part is watching the spread between where XYZ is trading and 50 bucks since it wont go all the way to 50 bucks right away. Time spreads will me a moot point.
    Taking guesses at scenarios and guessing at dates gives you ZERO basis to calculate probabilities. “Assigning” a probability based on nothing but guess work is not a good trading strategy, nor should it be considered any sort of hard analysis.
    Personally I think you bring up an interesting topic, and one that risk arb desks generally do well with because that’s their business. On the other hand that’s how they make their book and they have the ability to do the real research.
    I didn’t look at your charts but the skews in the options reflect the terms and time of the deal nothing more.