Friday, February 19, 2010

SII & SLB - SLB takeover Bid Coming; How Options, Skews React

SII is trading 37.65 up 4.30 (12.9%) with vol up 5 points. SLB is trading 63.75, down 2.06. The LIVEVOL™ Pro Summaries are below.

Here's the news from Reuters - click to enlarge (now on Livevol Pro):

So a bid is coming. "The deal would create an industry giant with revenues double that of rival Halliburton Co.", The Wall Street Journal said. This has a few implications.

(1) The short term downside for SII is much lower.
(2) The short term upside for SII is in flux.
(3) A deal this big has regulatory problems written all over it.

Here's how the options show you the same things as above through the skew chart (click to enlarge).

Skew Legend:
Red - Front month
Yellow - Second month
Green - Third month
Blue - Fourth month

(1) The red line (March Options) has a weird downward bending skew - like a reverse parabola as you get to the far OTM puts.
(2) The red line on the upside has a distinct upward kink - expectations are for ~$9 billion bid ---> ~$41.10 in SII. But maybe it's higher (or lower)?
(3) The vol is actually up today (see IV30™ in summary above) - this is far from a done deal.

Also note the distinctly lower monthly vol as you go further out (overlaid from the Options Tab near the bottom of the skew chart). This occurs b/c there is a legitmate chance this deal does go through, and options become worth parity (i.e. zero vol).

The Options Tab snapshot is included (click to enlarge). Note the action in the Mar 40 calls.

I'm not allowed to offer trade advice in any way. If you want to trade this, consider these questions as a guide:
(1) If there is regulatory approval required, how long does that usually take?
(2) What are the chances of approval? Is there a similar attempted deal(s) to compare to?
(3) Is there a potential for another bidder? You can read the blog on the AGU, CF, TRA saga (BLOG HERE) to see what happens when mulitple companies are involved. Typically prices rocket higher.
(4) Is there a potential for a rejection from SII shareholders to the SLB bid?

Taking these questions/answers - what is the fair price for the options in each month relative to each other? Setting a specific price can be hard (or impossible) - but comparing months to each other can be easier. Time spreads can be a great way to play these events - limited downside, beat the machines matching markets with each other with better analysis than a dopey quoting script. Then again - maybe they're right.

The basic approach we use on the floor when we trade this type of event:
(1) Create a few "likely" outcomes and assign stock prices to them
(2) Assign dates to the possible outcomes
(3) Assign probabilities to the above.
(4) See if your prices match the market
(5) Make cheap bets with big payoffs where you feel the probability distribuion is incorrectly priced.
(6) MOST IMPORTANT: If there's no opportunity according to your analysis - walk away.

This is trade analysis, not a recommendation.

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