Friday, June 13, 2014

* YELP - Takeover Blast-off; Has Option Market Totally Mis-priced Risk? Has the Equity Market Mis-priced Stock?

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YELP is trading $74.16, up 12.6% with IV30™ up 4.5%. The Symbol Summary is included below.

Provided by Livevol

It appears that the equity market reflects a likelihood now that GOOG will takeover YELP in response to the OPEN acquisition by Priceline. But, while the equity market seems decided that this possibility does in fact raise the valuation of YELP, the option market has a slightly different view.  Further, the option market essentially reflects an equilibrium level right now while at the same time reflecting heightened upside risk through June 20th, and then substantially less upside potential after that.

I recently wrote about YELP on May 20th 2014.  You can read that post below:
YELP - Everything You Need; And Why this Company May be Overvalued

I wrote in that post:
"[I]t's in the cracks and crevices [] but the accusations are out there, that YELP is a bully. That YELP is a cheater.

I like YELP the app. I use YELP. I rely on YELP. But YELP is not a $4B company as it's currently constituted. Not in my opinion. Operating margins are worsening quarter over quarter, are now and always have been negative, revenue growth has declined, and there isn't much more they can do with gross margins which are at impossibly high levels.

The best case for shareholders would be a takeover -- that price would (could) be over $4B.

Well, it's takeover fever that has caught YELP's stock price.  Here's the news today:
Hotel booking giant Priceline Group announced Friday morning that it will acquire OpenTable for $2.6 billion. Priceline -- parent company of,,, and -- will pay $103 per share in the all cash transaction, a 46% premium over the restaurant reservation platform's closing price Thursday.

Source: Forbes via Yahoo! Finance Priceline Reserves OpenTable For $2.6 Billion, Reservation Site Shares Skyrocket, written by Samantha Sharf.

So why does that matter to YELP? Well, it appears that the equity market reflects a likelihood now that GOOG will takeover YELP in response. But, while the equity market seems decided that this possibility does in fact raise the valuation of YELP, the option market has a slightly different view.

Let's start with the stock chart (all-time), below.

Provided by Charles Schwab optionsXpress

We can see YELP's meteoric rise from below $20 to just under $100, then the drop in the most recent MOMO deflation, and now an equally abrupt rise back up to the $75 range.  It's worth noting that even before this news, YELP stock had recovered significantly from the lows in May.

But that's the equity market... The option market isn't quite as optimistic but is also a bit cavalier in how little risk it reflects in the future stock price.  Let's turn to the IV30™ chart in isolation, below.

Provided by Livevol

The implied volatility is the forward looking risk in the equity price as reflected by the option market (IV30™ looks forward exactly 30 calendar days).

We can see that the risk as reflected by the option market for YELP stock in the future (i.e. the red line) is pretty low relative to the past. In fact, on an annual basis, the current IV™ is in the 21st percentile.  I gotta say, that just blows my mind...

YELP is not a $75 stock in a state of equilibrium.  Perhaps it's higher with a takeover, and I believe it's lower without a takeover, but the option market essentially reflects an equilibrium level right now.  In a sec we'll get to actual details as to how much equilibrium is priced into the option market.  I think it will surprise you... it did me.

First, let's turn to the Skew Tab snap (below), which  illustrates the vols by strike by month.

Provided by Livevol

We can see here a very interesting phenomenon.  The yellow curve which represents the equity risk in YELP through Jun 20th, is parabolic shaped.  That means that the option market reflects two-tailed risk in YELP stock price equally.  So, a big move up or a big move down are equally likely.  I think that's about right.

But... in Jul that risk paradigm changes entirely.  The skew shape in Jul is back to a "normal" shape, which in English means, greater likelihood of a downward tail event than an upward tail event. Said differently, the option reads that this "takeover stuff" is most likely to materialize in the very short-term when compared to the intermediate-term.

That's not uncommon, but does come back to the question, why is the volatility (that red line in the prior chart) so low right now?

To read more about skew, what is and why it exists you can click the title below:
Understanding Option Skew -- What it is and Why it Exists.

Finally, the Options Tab is included below.

Provided by Livevol

Using the at-the-money (ATM) straddle we can see that the option market reflects a price range of [$69.50, $80.50] by the end of trading on Jun 20th.

  • If you believe the stock will be outside that range on expiry or any date before then, then you think the volatility is too low.
  • If you believe that range is too wide, and that the stock will definitively be in that range on expiration, then you think volatility is too high.
  • If you're not sure, and can make an argument for either case, then you think volatility is priced just about right.

That's an $11 range, and YELP has moved ~$9 today alone.  Hmm....

This is trade analysis, not a recommendation.

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1 comment:

  1. Wouldn't a straddle using the July options roughly 30 days out be a better value? IV looks lower on those based on your skew tab snap.