This topic contains 3 replies, has 2 voices, and was last updated by  Erik Kobayashi-Solomon 7 months, 3 weeks ago.

  • #9827


    Are there certain trading rules you follow when a stock you own gets bid up on takeover speculation? I have had several like that I held only to see them decline months later (BMY, QCOM, and now SYNA to name a few). All seemed to have significant upside if a deal went through according to press reports, so I figured it was better to continue holding.

    Do you sell the stock when it pops or maybe write a covered call?


    Hi Wilson,

    Thanks for the question. I always look at where the price is sitting versus my fair value range. If I have made a good return before and after the pop and if the price is a lot closer to my best-case valuation scenario than my worst-case one, I'm a lot more likely to take profits on at least part of the position. This is especially true if the position includes options and the increased uncertainty pushes up option prices and makes the intrinsic value + time value close to my best-case value.

    Acquisitions are hard, especially when there are multiple regulatory bodies involved as with QCOM/NXPI. If you can structure an exit where selling part of the position will lock in a nice return no matter if the stock might fall after the deal conclusion is known, that's the best situation. Best-case, the acquisition goes through and you juice your return a little; worst-case, the acquisition falls apart, you still own a stub position, with which you can build a new position of the price / value relationship is still favorable, and you've already realized a decent return.

    All the best,



    Thanks for the quick reply, Erik.

    What is your opinion on replacing stock with calls to lower exposure?


    No problem, Wilson!

    The problem with doing so is that for acquisition situations, many times option pricing is very high due to the uncertainty. As such, one ends up buying very expensive time value, which I hate doing.

    Also, one thing to note is that replacing a stock with a call option is, by put-call parity, the same as overlaying a put on a long stock position. The pricing may not be the same, so if you're going to go down this road, check both ways of doing it for the least expensive.

    Also, you had mentioned selling a covered call before. If you're selling a covered call ATM, you'll likely get a lot of premium for it; you can use that premium to purchase an OTM protective put, hereby creating a “collar” structure that will guarantee some minimum profitability whether the transaction goes through or not…


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