Yahoo Options Spell Opportunity - Even If You’re Not a Billionaire

When Yahoo (YHOO) and Microsoft (MSFT) turned their interest away from each other last week, and Yahoo made an advertising deal with Google (GOOG), options activity exploded to over 500,000 contracts on Thursday and Friday.  This is double the daily average volume according to Joe Burgoyne of options analytics provider Ivolatility, who also noted that while volatility has jumped up about 10% for July options, it is still in the middle of its 52-week high/low range.  Volatility is a relative way of comparing option prices, all other factors being equal.  All this activity, without a panic spike in volatilities may indicate some solid opportunities for option investors who have a view on Yahoo.

Last month, billionaire buy-out king Carl Icahn established a 49-million share position in Yahoo using options, as reported by the Wall St. Journal and The Options News Network on May 16^th.  Icahn accumulated his massive options position when Yahoo shares were trading around $25.  Things looked pretty good for him for a couple of weeks as the stock climbed above $28 and other activist investors chimed in to support his overthrow of existing board members who were blocking the Microsoft bid.  But, when hopes that Mr. Softee would be able to get a deal done faded again, Yahoo fell over $3 last Thursday. 

Do things look bleak now for the master deal maker?  Given the Google partnership announced Friday, he might be consoled somewhat.  And given the fact that the European put options he sold reportedly had a strike price of $19.50, we might assume he was always ready to buy Yahoo shares at that price if the options were exercised.  This is because as the seller of the puts, Icahn has given the buyers the right to be short Yahoo shares at $19.50.  So, if Yahoo falls below that price, the put option buyers would exercise their rights and Icahn would be “assigned” by the Options Clearing Corporation [OCC] to purchase 100 shares of Yahoo stock for every put option he sold.  The OCC is the organization that guarantees orderly fulfillment of option contract terms and regulations.

Since Icahn sold 490,000 put options with an expiration date of November 5^th, 2010, that means he would have to be ready to buy 49 million shares of Yahoo for $19.50, up until that date, if the stock falls below that price.  This is a very risky trade that should only be attempted by option investors who are prepared to buy the underlying stock.  It is called a “cash-secured put” and is often referred to as “naked” selling because it is not hedged by stock or another put.  But, of equal note when looking at the risks of this trade is the fact that Icahn sold European put options, which cannot be exercised before expiration.

So, what do all these billionaire maneuvers have to do with us?  Well, if you like Yahoo as an investment play here and believe in the value of the enterprise for any partnerships or deals with a Mr. Softee or Google, then now might be a good time to try your own options strategies.   Volatility has come back down a bit from the mid-50’s to the mid-40’s and with Yahoo shares trading down here this week,  just above $23 on Tuesday, call option prices are attractive.  The October 25 calls are trading around $1.60 with implied volatility of about 43%.  This option gives you 4 months to play the continuing saga of Yahoo-Microsoft-Google-Icahn with low risk, low initial investment, high leverage, and high flexibility—the top four benefits of all options trades.

If some deal is done back up north of $30 between now and October expiration, your 25 strike call option will be worth over $5.  And, if you have sufficient options experience for your broker to allow you to sell a cash-secured put, you might want to be like Icahn and also take the bold position of a naked put seller.  The October 20 strike puts are trading for $1.10 at 48% volatility and would obligate you to buy Yahoo shares at $20 if the stock falls below that price between now and options expiration.  In effect, you would be buying Yahoo at under $19 (excluding commissions) because of the $1.10 in premium you collected.  But, if Yahoo stays above $20, you get to keep the full premium as income and you have paid for part of your call purchase.  This is exactly what Icahn did in May.

For you chartists out there, I should add one more reason for my speculative bullishness on Yahoo.  When the stock dropped below $22 last week, it touched and closed above some areas of key support—the 2006 and 2007 lows.  If Yahoo can hold these lows and not revisit its 2008 low of $19.05, where it launched $10 from on February 1^st after Microsoft first expressed its intentions, it will be building a solid base.

I’ll let Icahn, Microsoft, and Google worry about the fundamentals of Yahoo shares.  They must certainly know more than us.  And, we can ride their coattails.  For full disclosure, I will buying some Yahoo calls this week after this article is posted.  Come on Carl, let’s get something done!

Disclosure: Author plans on buying Yahoo calls this week

Comments

[dgdatta]

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