Thursday, July 1, 2010

BJ Wholesale Club (BJ) - Stock Rips on Rumors; Vol Jumps on Uncertainty

BJ is trading $43.28, up 16.9% today with IV30™ also rising 13.8%. The LIVEVOL™ Pro Summary is below.

The news from the AP is this:
A private equity firm has bought a large stake in BJ's Wholesale Club Inc. and says it plans to talk with the warehouse club's executives about the potential for taking the company private.

Green Equity Investors bought 5.1 million shares of BJ's stock and said the shares are undervalued, according to a regulatory document filed Thursday. That represents about 9.5 percent of the company's shares.

Green Equity plans to discuss options for improving shareholder value including taking the company private, new financing or other transactions.

The company has traded over 8,200 options on total daily average option volume of just 578. The action is in the front month 40 puts, 45 calls and the Aug 45 calls as well. The Stats Tab and Day's biggest trades snapshots are included (click either image to enlarge).

The Options Tab (click to enlarge) illustrates that all three of the high volume lines are mostly opening (compare OI to trade size). I believe the July calls and puts are purchases; I can't tell about the Aug 45 calls - but I'm guessing long based on the order flow.

Let's take some time to look at the Options Montage and see if we can back out any probabilities or identify good trades.

1) The Jul 40/45 call spread is $3.28 in the money. Right now mid market has it worth $2.95. The max gain is $5 - cost = $2.05. Max loss is the price = $2.95. Max Gain/Max Loss = 2.05/2.95 = ~0.70

If everything were random, with the stock at $42.50 you would expect a 1/1 ratio of max gain to max loss (normally we also need to consider cost of carry, but rates are low and this is short term so we'll skip it). This front month call spread doesn't help much, as 0.70 seems about right with the stock at $43.28.

2) Another interesting trade could be to sell the Jul 45 calls against a purchase of the Aug 45 calls for $0.80. That would be buying 33 vol and selling 36 and hoping for the stock to expire just below $45 and then either sell the Aug calls out after the Jul expire worthless, or even more ambitious, hope the stock does in fact realize a price well over $45 on substantiated news.

3) On the flip side, an Aug/Jul 40 put spread costs ~$0.70. If you think this is non-sense but the stock remains above $40 until July expo, that could be a nice winner.

4) Finally, if you just think the vol is too high right now (see charts tab discussion below), you could sell the straddle you think the stock is going to. i.e. If you think it pins at $45, sell that straddle, if you think it drifts down to $40, sell that one. You could cover up with the July 35/50 strangle for ~$0.10 if you had to. It would have been nice if the 42.5 strike were available in any of the months.

Trade Stats
Sell 1 July 40 straddle @ $3.55 + $0.35 = $3.90
Profitable at expo if stock ($37.10, $43.90)

Sell 1 July 45 straddle @ $0.60 + $2.30 = $2.90
Profitable at expo if stock ($42.10, $47.90)

The alternative is to buy the high vol and therefore buy the straddles.

The Skew Tab snap (click to enlarge) illustrates the vols by strike by month.

Since the skew has found it's prices (i.e. discovery period is over), there aren't any big kinks, and therefore not necessarily any obvious trades. If you disagree, let me know.

Finally, the Charts Tab (6 months) is below (click to enlarge). The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue). The yellow shaded area at the very bottom is the IV30™ vs. the HV20™ vol difference.

We can see the stock has ripped today and IV30™ has pushed past the the HV20™ which indicates low certainty of this transaction. Usually, if a take out deal is considered high probability, the vol goes down. That doesn't mean it won't happen, it means the market reflects no strong opinion yet.

This is trade analysis, not a recommendation.

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