- We’re starting to see small M&A deals announced almost every day, and that is followed by rumors almost every day about which company may be next in line to be acquired.
In recent days and weeks, there have been rumors about RadioShack Corp. (RSH), Palm (PALM), Lexmark International (LXK) and Polycom Inc. (PLCM). Then there’s Novell (NOVL), which actually received a bid, but turned it down and has started looking elsewhere.
History dictates that the vast majority of rumors never materialize, and if you acted on every takeover rumor out there, you would be broke. But there are many ways to skin a cat with options, and you can use them to afford you some downside protection if you are planning to bank on a deal, or to bet against the rumor. So, based on the likelihood and time frame of the deals for the companies mentioned above, here are five option trades to do just that.
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RadioShack Corp. (RSH)
On Friday, March 26, RadioShack Corp. (RSH) rose from $22 to almost $24 on takeover rumors before petering out. What is interesting is that the stock has slid back down to $22.80, and the profit-taking came immediately on Monday, March 29, as there was no deal announced.
Now the chart looks questionable. While the time for the bullish trade was Monday, the best hedge or bet against a deal here is the RSH April 22.50 Puts (RSH 100417P00022500) under 70 cents. That gives you limited downside and still offers about three weeks of protection.
It seems unlikely that a deal would come higher than $25, and looking at options activity in RSH, it doesn’t appear that traders are anticipating anything above $23.50 to $24.
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Palm (PALM)
The rumor mill is throwing out names like Dell (DELL), Hewlett-Packard (HPQ), Nokia (NOK), Research In Motion (RIMM) and on and on as potential acquirers of Palm (PALM). Maybe Bono would bite the big one and try to just get his Elevation Partners to take it private, but don’t hold your breath on that one.
We already made triple-digit gains riding Palm down with put options, so rather than continuing to play the short side, the outlier bet is actually to play the short-dated call options just in case the bidding frenzy does ignite. Buy the PALM April 4 Calls (UPY 100417C00004000), currently trading around 20 cents. This bet may be a bit of a stretch, but it is a low-premium trade that can be rolled. Palm will almost certainly get acquired, but the question remains whether the buyout will be a takeunder from a predator after things get even worse for the smartphone maker.
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Lexmark International (LXK)
Lexmark International (LXK) was touted on March 23 and 24 as a potential takeover target via a leveraged buyout (LBO), according to Bank of America/Merrill Lynch. Interestingly, the stock gapped from $34.89 to $36.73 before it petered out. At $36.80, the follow-on buying has been slim, even though options activity in the LXK April 35 Calls (LXK 100417C00035000) and LXK April 40 Calls (LXK 100417C00040000) has been active.
The bet here is the LXK April 35 Puts (LXK 100417P00035000) below 60 cents. With a 52-week range of $14.23 to $37.35, does it seem a private equity buyer would want to hop all over this for a major premium? LXK was at $26 at the start of the year, so even in a strong bull market, there are big expectations already priced in here with or without any buyout rumors.
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Polycom (PLCM)
Polycom (PLCM) run up almost 10% on St. Patrick’s Day rumors, but actually dropped following March 19 rumors that Apax Partners may buy the company for as much as $3 billion (its current market cap is $2.6 billion). That would be a 15% upside if it did not include financing debt or other expenses.
The stock has given back its gains, and the company has been under pressure over the Cisco Systems (CSCO) purchase of Tandberg as communications competition. This should have been hedged or bet against back on the rumor date gains, but there is still the opportunity to hedge it. Here we’d take a longer approach with the PLCM July 30 Puts (QHD 100717P00030000) around $2.25. A deal doesn’t even have to not come for that to possibly be a winning bet against the company. By then it will be known if Cisco will be winning more and more business in the telecom and video space.
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Polycom Novell (NOVL)
Novell (NOVL) is a pending deal. The problem is that Elliott Associates’ $5.75 buyout offer price is one that Novell could not accept even if it wanted to, because it would bury too many longer-term shareholders. Novell may be worth more under the right circumstances, but it is worth far less than today’s price if no alternative merger offer comes.
The best play here is a straddle. Buy the NOVL May 6 Calls (NKQ 100522C00006000) and NOVL May 6 Puts (NKQ 100522P00006000) for about 30 cents each. It is hard to imagine a bidding war here, but no circumstances known today can make the company accept a $5.75 deal, even it means the stock goes back under $5.
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