Picture this: Two companies decide to join forces and create a formidable powerhouse in the market. Sounds exciting, right? But let’s face it, these M&A events can be as nerve-wracking as riding a rollercoaster blindfolded. Stocks soar, fall, and loop-de-loop with every announcement, leaving investors gasping for breath. Holding shares of either company can result in serious upside, or make you seriously upset. How can you navigate these events as a shareholder, or speculate on these events as a trader?
Enter Options: Your Safety Harness in the Stock Market Rollercoaster
Fear not, fellow traders! Just like a sturdy safety harness keeps you secure on a rollercoaster, options can protect your portfolio during these turbulent times. When the market’s going crazy, and you’re not sure if it’s up, down, or spinning in circles, options are the tool that professionals use to hedge their bets, minimize risk, or speculate for profit.
We’ve seen this as of late with the highly publicized attempted acquisition of Activision by Microsoft. Market Rebellion spotted unusual options activity the week before news of the merger leaked, and once the news hit, shares of ATVI were off to the races. However, following numerous attempts by antitrust agencies across the globe to block the acquisition, we’ve seen more twists and turns than we care to count. That’s why it’s important to remember the most important thing about trading options during mergers and acquisitions.
Risk Management: Don’t Ride Blindfolded!
Options can be your trusty compass in the world of M&A chaos, but as with any trade you make in the stock market, you have to exercise discipline. Let’s say you own shares in a company that’s part of an impending merger. You’ve got a good feeling about it, but there’s that sneaky little voice in your head saying, “What if things go south?” Whether it’s a “buy the hype, sell the news” style event, or the stock market collectively decides that one side got a bad deal, you need to know how to use options to protect against the unexpected.
In that case, longs and shareholders can use put options to protect their precious shares from potential nosedives. If the stock takes an unexpected plunge, your put options come to the rescue, limiting your losses (and even potentially generating gains), saving the day. Most popularly, OTM put options near the date of the potential acquisition are utilized in these events, as they are cheap insurance that don’t negate your long position. If you’re a true bull on the company you own, you wouldn’t want to overpay for these put options or buy too many — or else you run the risk of accidentally changing your directional bias. A common rule of thumb is that your hedge should cost no more than 10% of the value of your correlating long position.
So for instance, if you were holding 10 shares of Microsoft (currently priced at roughly $345 per share), and you wanted some potential downside protection against negative news surrounding the merger, you might opt for a $325/$300 put debit spread expiring on August 18th. This gives about a month of protection against the unknown, for a current price of $3.23. If shares of Microsoft are trading at or below $300 on August 18th, your spread will expire at a max value of $25.00 ($2,500 real dollars).
If the total value of your 10 Microsoft shares were $3,450 (10 shares), that would mean you spent less than 10% of the value to protect you all the way down to a share price of $99.50! This may be overkill, and there’s no reason to overspend on insurance if you aren’t particularly worried, but for investors who are worried about any type of potential downturn, options make an incredible hedging tool.
Speculative Opportunities: The Thrill of the Unknown!
Alright traders, this one’s for you! While some investors like to play it safe, others thrive on the thrill of making a big trade, leveraging themselves to spend as little as possible for the best possible outcome. Options offer the perfect playground for adventurous traders looking to capitalize on the wildest market swings. Mergers and acquisitions have the propensity to do that.
As an example of how you might speculate on an options trade through an acquisition, imagine you’re looking at Microsoft and Activision. After reading the recent news that the deal is likely set to go through, you’re looking to make a buck on the event. With a bit of research, your learn that through the $69 billion dollar deal, Microsoft intends to buy Activision for $95 dollars per share. Shares of Activision are currently priced at about $92.50. Instead of spending $92.50 per share to make a potential $2.50 per share (a total gain of ~2.7%), you start analyzing the options chain.
After a bit of looking, you conclude that the August 18th $94/$95 debit spread is currently trading for $0.32 dollars, and has a max value of $1.00. That mean if you’re right that the acquisition is set to go through by August 18th, you’ll make 212.5% of your initial investment — without even having to risk the $92.5 share price. If you’re wrong, and the acquisition doesn’t go through, or it doesn’t go through by that date, you’ve mitigated risk, and you aren’t stuck holding onto shares of a company longer than you needed to.
Conclusion: Options – Your Sidekick in the M&A Adventure
Options are the Robin to your Batman in the world of mergers and acquisitions. They stand by your side, providing risk management when you need it the most and exhilarating speculative opportunities for the daredevils among you.
So, the next time you’re riding the M&A rollercoaster, remember this: with options in your toolkit, you can ride fearlessly through the loops and twists of the market, all while keeping your portfolio safe and sound. Embrace the adventure, and may the profits be ever in your favor!