Skip to main content

Morning Update

The economic news this morning is mixed with retail sales coming in at a surprisingly strong 0.5% increase while the Empire State Manufacturing Index missed big, printing -7.78 on expectations it would be zero. This is the 6th negative print in a row and the 5th big miss in a row. Overnight the US also got a warning from Fitch who warned that “If we have a repeat of the August 2011 debt ceiling crisis we will place the US rating under review. There will be a material risk of the US rating coming down.” In August 2011 the S&P 500 dropped over 15%, which would not be out of the question if a similar event occurred in February. The best indicator of the market’s anxiety over this is the February VIX future, which is tied to March SPX options and is due to expire on Feb. 13th, just days before the US is expected to hit the debt ceiling.

Yesterday shares of Dell jumped 13% on reports that the company was in talks with several private equity firms about going private. This morning Jefferies raised their price target on the stock to $13 “to reflect the possibility of” a leveraged buyout. Option trading on the stock was decidedly bullish with 3.8 calls trading for every put on nearly twice the average daily volume. One of the biggest trades of the day was the purchase of 2500 January 2014 15 calls for $0.50 with the stock at 12.36. This is a bullish bet that the stock will reach at least 15.50 by this time next year.

As option traders scrambled to buy out of the money options on the buyout rumors implied volatility in the stock skyrocketed. 30-day implied volatility closed at 52.97%, up 65% on the day. This means that options are quite a bit more expensive now as a result of the heightened uncertainty surrounding the stock. While this did not dissuade this trader from buying long dated deep out of the money calls, I believe traders need to take a step back and analyze the situation before joining the call buying frenzy.

A key metric private equity firms look at when analyzing a deal is enterprise value. Enterprise value is basically the market cap of the stock plus outstanding debt minus cash and investments. Private equity firms like to buy companies below enterprise value unless they believe they can unlock major synergies through the acquisition to create new value the market is not pricing in now. Dell’s current enterprise value is $12.54 per share which is below yesterday’s high. This doesn‘t mean that someone wont buy Dell above enterprise value, but it does make it less likely that a private equity firm will pay a big premium over yesterday’s closing price.

Another headwind facing a buyout of the stock is Michael Dell’s personal stake in the stock. Currently he is the company’s largest shareholder with a roughly $4.5 billion position. It is unlikely that a private equity firm would want to be a minority shareholder in the stock, and yet there are few firms likely to put up over $4.5 billion to become the largest shareholder. Again, this doesn’t mean that a deal cannot be done, but it means that a deal will require serious financing and will not appear overnight.

The key to playing this stock will be to keep risk small and reward high. Buying out of the money calls that expire in a year like this trader did is probably a good way to go if you want to step into the stock today. Long dated options are less sensitive to initial spikes in volatility which means that they will have more reasonable premiums than the short dated options. They also have less time decay and give the trade time to work. After such a big one day run on nothing but a rumor I would think the stock is due for a pullback sooner rather than later as traders take some profit off the table. If you want t buy calls on the stock I would wait to do it on a dip after the initial frenzy has abated.

Comments

Popular posts from this blog

I would like to bet ten tens on the tenth horse in the tenth race, please.

"I would like to bet ten tens on the tenth horse in the tenth race, please."


Last summer, on a warm cloudy day June 11, 2016 in Elmont New York, a good friend of mine (Rob) confidently walked up to the cashier at Belmont and spoke those famous words.  Ten Tens on Ten in the Tenth Race.  In fact, it had been decided it months earlier. We had been discussing hosting his bachelor party in New York, go to the Belmont Stakes, and watch a Yankees vs Tigers game and Rob convinced the group to go to New York by proudly proclaimed his prophecy.  I had almost forgotten about this bold prediction when I witnessed him at the register, but when I looked up, and saw Flintshire, the 10th horse in the race upcoming race was the favorite.  “What could possibly go wrong?”  I thought to myself (an options trader who bought a racing program attempting to handicap and gain an ‘edge’ in the previous nine races unsuccessfully).  I went to a pretzel vendor and changed 5 twenties into ten tens, wal…

Is the KCJ Foreshadowing a 2008 Repeat?

The CBOE Correlation Index (KCJ) is close to the lowest level we have seen since it was first listed in 2007. The KCJ measures the implied movement of the S&P 500 components options, compared to the implied movement of the S&P 500 index options. Simply put, the higher the number, the more likely all stocks are going to move together. Conversely, a low number will be characterized by sector rotation, and flat markets; one sector moves higher, another moves lower. 
Correlation, for lack of a better term, is correlated with volatility. Not surprisingly, 30-day S&P 500 historical volatility is near the low level of 6.5%. Currently at 33.5, KCJ is sitting close to rock bottom, lower than where it was in 2007, (but not lower than where Lindsay Lohan was in 2007). 
So far this year, the market has been able to grind higher, characterized by leadership in FANG(Facebook Apple/Amazon, Netflix, Google) and sector rotation. As the summer hit, FANG has slowed with GOOGL and AMZN hitting…

The market should take Trump seriously this time.

Kim Jung-Un gave the U.S. an unwelcome birthday present as he test launched an ICBM capable of reaching Alaska.  North Korea has made it very clear that their intention is to grow their nuclear capability to be able to reach the Continental United States.  This would destabilize the region, and world overnight.
Now I don’t expect the war drum beating will spill over into mortar shells raining down on Seoul anytime soon.  There has been a choreographed diplomatic dance going on for the past 40 years with North Korea that is likely to continue as follows; North Korea acts out, U.S. gets upset, U.S. sanctions them (with help from China).  North Korea gives up their acting out activity (promises they won’t do it again), a North Korean South Korean gesture of goodwill takes place, such as joint Olympic teams, joint economic projects, North Korea gets to declare victory.
However, this go around seems slightly different.  Now we have a President who has made it very clear in his campaign tha…