A funny thing happened when AT&T (T) announced it was buying satellite TV operator DirecTV (DTV) for $95 per share: DTV stock didn’t go to $95.
Instead, DTV has settled in the mid-$80s and doesn’t seem to want to go anywhere.
That’s because the market is pricing in the possibility that the buyout fails, and for a pair of good reasons. The first concern is that the deal is contingent on DirecTV being able to renew its NFL Sunday Ticket arrangement with the league. The second is that regulators may kill the deal.
The result? At least one analyst has posited a 15% probability that the buyout will fail, and DTV stock trades just above $84.
So, what’s a DirecTV shareholder to do?
Trading Strategies for DTV Stock
Interestingly, I had sold some DTV stock naked puts at a strike price of $87.50 for around $3. The 300 shares were put to me, so I now hold shares of DTV at the equivalent of an $84.50 buy point.
If the merger goes through, DirecTV stock will shoot to $95. The problem is that I think it will be at least six months before this happens, and it already has been three months since the announcement. Do I really want to wait a total of nine months for a 12% return?
Plus, there’s always the risk that the merger fails, in which case DTV would likely drop to the mid-$70s.
So here’s what I’m going to do.
I’m going to remain long, but I’m also going to hedge … and I’ll do it all with options. (And full disclosure: This is a complex options trade, so proceed with care.)
First, I’ll sell my DTV stock, and that will mean I’ll basically break even.
Then I’m going to buy three DTV Sep $55 Calls, which are going for about $30. By buying deep-in-the-money calls, I’m paying very little premium. Once expiration arrives, I can sell the calls and incur whatever gain or loss results, then repeat the process for December or January. So I will always have a long position.
Now I’ll hedge that long position. First, I’ll sell the Dec $85 naked puts for $3.95. I don’t expect any announcement by then. So I should be able to pick up that premium without much risk.
I’ll also sell three Sep $85 naked calls for $1.25. If the stock is below $85 by then, I keep the premium. If the stock is above that, I’ll need to cover that position because I’ll be required to sell 300 shares of DTV stock to the owner of those calls. Fortunately, I have three Sep $55 DTV calls, so that position is covered. Since I purchased them at $30, they will be worth at least that when I am forced to sell.
I don’t expect the merger to close by Sept. 20, so I can just buy those three calls again to maintain by long position.
If the merger has failed for some reason, and the stock falls to $75 or so, then here’s how it shapes up for me:
- The Sep $55 calls are now worth $20, so I have a $10 loss.
- This is offset by the $3.95 in premiums for the Dec $85 naked puts I sold.
- It is also offset by the $1.25 naked calls I sold.
- Total offset is $5.20, so my loss is $4.80.
I also have three more months to wait and see if I have more DTV stock put to me at $85 from those naked puts.
But all of this is predicated on one thing that I believe, and that you must believe if you’re going to try this (admittedly complex) options trade: I’m glad to take the stock.
DirecTV is a great company on its own, well-managed and in an industry with relatively few players, and lots of potential for consolidation even if the DTV-AT&T merger falls through.
So, should DTV get put to me, I’m happy to have the stock — and if anything were to change my opinion by then, I could sell covered calls to reduce my losses.
As of this writing, Lawrence Meyers was long DTV, but will make the above trades within 72 hours of publication. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at pdlcapital66@gmail.com and follow his tweets at @ichabodscranium.
