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Surprise, Surprise. Another day is upon us, and there is another rumor for Yahoo (NASDAQ:YHOO). So it goes in the world of Yahoo.

YHOO is a digital media company in the process of reorganizing or perhaps being sold. It appears just a matter of when and at what price.

Recent Rumor Timeline:

12/7 - The Deal Journal reports that Yahoo has asked for more information and better terms from potential buyers as the company contemplates various scenarios regarding a sale of a minority stake in the firm.

12/2 - Private equity firm Silver Lake is rumored to be purchasing a stake in Yahoo. Although not a full-blown takeover, analysts theorize it may be the company's most desirable option.

11/30 - Yahoo rallies nearly 4% after hours on the heels of a Bloomberg report that an Alibaba-led (OTC:ALBCF) group is readying a takeover bid for the entire company. The price Alibaba is apparently willing to pay trumps other offers for minority stakes put forth by various private equity concerns.

11/29 - There is apparent interest in Yahoo's U.S. operations from THL Partners. The purchase of just the U.S operations of Yahoo is in conflict from other presumed bidders who are looking at either buying minority stake in Yahoo or partnering with its Asia concerns. The value of the deal is rumored to be significantly north of $5B.

11/29 - Yahoo rallies over 2% following the latest rumors of bids from various PE firms.

11/8 - Yahoo gaps higher on persistent rumors that Softbank and Alibaba are readying bids for the company.

11/7 - Yahoo spikes higher after the Financial Times claims the company is near a sale of all or part of the company.

If you ascribe to the theory that where there are smoldering embers, a blaze may soon ignite, here are some option plays to consider.

Three Takeover Options Plays

This is a stock with seemingly perpetual takeover rumors. The upside skew in the December weeklies and the December monthlies is persistent. This is indicative of the takeover potential for this company and is appropriately reflected in the option prices.

An interesting side note is that the at-the-money (ATM) implied volatility in the weekly (front) expiration is the lowest of the near term months. There appears to be little belief in the marketplace of an imminent takeover in the next day or two, but rather a deal sometime in the future.

In the front few months, we can see the upside skew is quite bid - takeover skew, as traders call it. This has been the norm for YHOO for some time, as the bids for out-of-the-money (OTM) calls get elevated each time there is a new takeover/minority stake rumor.

Due to the persistent takeover rumors, the 30-day implied volatility of the YHOO options is quite elevated. The 30 day implied volatility is trading around 54.70%, significantly higher than the 52 week implied volatility low of 29.89% hit early this year.

Trade idea #1 - All Cash Deal

If you believe that some takeover is in the works and the deal may be an all cash deal for YHOO, consider this trade idea:

To let this view time to play out, let’s go out to the Jan 14 options. A simple covered call with a far dated expiration is a suitable option play for an all cash deal.

The Play: To take advantage of the fact that a cash deal essentially strips any extrinsic value out of an option.

  • Sell Jan ’14 20 calls for $1.30.
  • Let’s buy the underlying at $15.71

Why a covered call? There are two reasons:

  • Any cash deal under $20 yields the seller full option proceeds of $1.30 For example, if there is a $20 cash deal, you would receive the full $1.30 in option premium plus the appreciation in your underlying position.
  • With a stock only and/or a combination of a partial stock/partial cash deal, the final takeover price of the deal is contingent upon the performance of the acquiring company’s underlying price. With a cash deal, the terms are stated and final once approved. The performance of the acquirer does not affect the trade’s return.

Trade idea #2 - A near-term takeover deal

For those who view a deal as a near term possibility, let’s do a near term bull call spread.

The Play: To capitalize on the upside call implied volatility skew.

  • Buy December ’11 16/20 call spread for @ .40 You are buying the December’11 16 strike calls for approximately a 53.4% IV (Implied Volatility) and selling the December ‘11 20 calls for an 84.2% IV.
  • Net debit: $0.40
  • Maximum Profit: $4.60

The sale of the Dec ’11 20 calls caps the upside profit to $4.65 and lessens the debit by $.05. One could further lessen the debit by substituting the sale of the 20 calls with the 18 strike calls ($.13) or the 19 strike calls ($.08). Remember, however that using these strikes in any spread lessens your potential profit by $1 and $2, respectively.

Trade idea #3 - Pure Speculation

For those who view a deal as a near-term possibility and do not want to cap the upside profits.

The Play: Utilize speculative monies only to buy near term OTM calls.

  • Outright Buy Jan 17.5 calls @ .52 This is approximately a 54.9% IV (Implied Volatility). This may appear high, but however, what is important is the leverage received from buying these options. One must be aware that these options may most likely expire worthless. This is a purely speculative play. Don’t use the kid’s college fund on these trades.

Risk: Time is not on your side in this trade. The real premium is reasonable, but in 5 weeks these options will expire and if the underlying is not over $17.5 a share, you will lose your entire investment.

Prices quoted where the prices at time of submission, and do not reflect current market prices.

Disclaimer: We are not liable for any trading decisions made by any reader. No advice is given or implied. The information offered in this article is for demonstration purposes only and should not to be either construed as an offer or considered to be a recommendation to buy or sell any options.

Your use of this information is entirely at your own risk. It is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. You must assess the risk of any trade with a professional broker, or financial planner, and make your own independent decisions regarding any trades mentioned herein. This is not a solicitation to buy or sell any options, or to purchase or sell any credit spreads. Trading options only carries a high degree of risk, is not suitable for all traders/investors, and you may lose all of your premium money invested in the options. If you have never traded options before, we strongly recommend that you read a little background information made available by the government. Only you can determine what level of risk is appropriate for you. Also, prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options.

Past performances do not guarantee future results. Please consult with your own independent tax, business and financial advisors with respect to any trade. We will not be responsible for the consequences of anyone acting on this purely demonstration material.

Source: Yahoo: Options Trades For The Rumor Du Jour