Monday, May 17, 2010

Pactiv (PTV) - Trading an LBO

Update (9:14 PST):
It looks like the Jun 25/30 strangle is also getting purchased (Jun 25 puts/ Jun 30 calls both purchased). This order flow is consistent with the original post.

PTV is trading 28.80, up 20.2% with IV30™ up 39.6%. The LIVEVOL™ Pro Summary is below.

The News (Click For Full Story).

NEW YORK, May 17 (Reuters) - Private equity firm Apollo Management is in discussions to buy Pactiv Corp, the maker of rubbish bags and food storage bags sold under the Hefty brand, a source familiar with the situation said on Monday.

The news was earlier reported by the Wall Street Journal which said any deal was a few weeks away and faced several hurdles.

Apollo and Pactiv declined to comment. Robert Baird analyst Ghansham Panjabi said a deal would make sense for Apollo, which has a similar investment, in plastic packaging firm Berry Plastics.

"The Hefty brand is pretty powerful," said Panjabi. He thinks a deal could value Pactiv about $34 a share.

On that, the company has traded over 8,500 options in the first hour on total daily average option volume of just 603. The biggest trades are time spreads. The Stats Tab and Day's biggest trades snapshots are included (click either image to enlarge).

The Options Tab (click to enlarge) illustrates that May, Jun and Aug 30 calls are in play. From the day's biggest trades section I see that the largest trades are getting short May 30 calls, and buying the Jun and Aug 30 calls. The tab also demonstrates the vol levels for each month (at the top).

The Skew Tab snap (click to enlarge) illustrates clearly what vol the trade is buying and selling (I have highlighted the 30 line for all three months).

You can see the elevated level for the front month (red) relative to the Jun (yellow) and Aug (green) on that line. Not to over simplify but, the trade gets short expensive vol and long cheaper vol.

Let's look specifically at the largest trade of the day a May 30/Aug 30 call time spread (buy Aug sell Jun) paying $1.10 total 1,000x.

Buy Aug 30 calls for $1.35
Sell Jun 30 calls @ $0.25
Total outlay (max loss) = 1,000 * 100 * $1.10 = $110,000

If we assume the stock stays below $30 into expo (i.e. stays about here), then the trade is left long 1,000 calls for $1.10. If the analyst is correct (news above) that the deal goes for $34, that's a huge win as long as it happens before Aug expo (which seems to give plenty of time for a deal to materialize). But, the article also reads that deal faces "several hurdles." That's why we see vol rising, not falling. So a $34 takeover is far from assured.

Alternatively, if the stock stays below $30, the holder of the calls could sell 50,000 shares of stock to turn those calls into a straddle. Using put-call parity that's about a $2.20 straddle. So, if the deal goes through at $34 it's still a winner (i.e. $4 - $2.20 = $1.80 win x 1000 spreads = $180,000), but, if the deal falls apart and the stock drops to it's closing price on Friday ($23.97) it's also a big winner ($6.03 - $2.20 = $3.83 win x 500 straddles = $191,500).

Of course, some news could come out before this week, making the above scenario analysis useless. Either way though, buying the back months gets long vega and it bets (and wins) to large moves (and loses to stagnation). The bet is either that the takeover price is well higher than the current level or, the failed takeover pushes the stock down well lower than the current level. You can take the other side of this bet buy essentially doing the opposite trades.

You can do similar analysis using the Jul/Jun 30 call spread. The spread is cheaper (Juli s cheaper than Aug), but it gives less time for the deal to materialize (or fall apart).

This is trade analysis, not a recommendation.

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