Dow and Rohm & Haas: Just Negotiating

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Includes: DOW, ROH
by: Jack Walker

In IVolatility Trading Digest™ Volume 8, Issue 47, Bad News, dated December 8, 2008 we suggested selling a Jan 70 put on Rohm & Haas (ROH) (64.76) based upon the proposed $78 per share takeover bid by Dow Chemical Co (NYSE:DOW) (15.41).

Since then, the Kuwait Petroleum Company has indicated that it will back out of their proposed Joint Venture with Dow for a new company called K-Dow. Since Dow had been planning to use the joint venture proceeds to finance the ROH acquisition, it created doubt about the ability of Dow to continue with the ROH acquisition, causing the shares of ROH to drop more than 15 points to under 50. Now back at 64.76 some analysts think the deal will still be completed but at a new negotiated price. If so, the new price remains the subject of the current speculation.

Our original suggestion in early December was for the sale of the Jan 70 put at 5.60 when it had an implied volatility of 63.89. This put is now selling at 8.60 with an implied volatility of 102.95 for a mark-to-market loss of 3.00.

We think the Kuwaitis are too smart to walk away from the joint venture since they know the necessity of diversifying their economy for the long term and since Dow has the management experience they are the best joint venture partner available. We doubt the Kuwaitis will lose this opportunity but will use it to improve the terms of their joint venture deal with Dow.

With a current Historical Volatility of 70, consider selling another ROH put that is now 14.76 out-of-the-money.

  • Sell ROH Jan 50 put ROHMJ 2.425 IV 166.37 Delta .1744

The credit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the credit Monday should be about 1.85 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .17 for each point change in the stock price.

In addition, since we think the deal will be completed after negotiating new terms we suggest a bull call spread on Dow as follows:

With a current Historical Volatility of 96, look at this spread idea.

  • Buy Dow Jun 17 ½ call DOWFW 1.55 IV 58.34 Delta .4423
  • Sell Dow Jun 20 call DOWFD .90 IV 56.50 Delta -.2996

Debit .65 Postion net delta .1427

The debit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the debit Monday should be about .64 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .14 for each point change in the stock price.

To protect the downside we suggest using a close below 14 as the SU (stop/unwind).

This position has a limited and defined risk of the debit while the reward is limited to the difference between the strike prices less the initial debit or 1.86 for a risk to reward ratio of 2.9. Further while the maximum risk is .64 it can be further reduced by following SU (stop/unwind) at 14 suggested above.

The combination of adding to the ROH put and initiating a new Dow call bull spread keeps us in this position with a minimal increase in risk exposure.

Disclosure: no positions