From Keith Harwood, OptionHotline.com

What is happening in the land of mergers & acquisitions?

First, we have Twitter, set to be acquired for $54.20 by Elon Musk, and yet the stock is only trading $40.  That’s a more than 35% discount.  Clearly, the market doesn’t see this deal going through at $54.20, but what if it does happen?

Get Keith’s Market Maker Cheat Sheet here for free!

Then, we have Kohl’s, just announced to have entered into exclusive negotiations with Franchise Group, Inc. to potentially be acquired for $60 per share, and yet is trading for only $45.60.  Another stock trading at an incredible discount of greater than 30% to the potential acquisition price.

So, if the prices are right, the market is wrong.  But there’s big money at stake for being wrong in the market.  That means that right now, there’s simply no one confident enough to bet that either of these deals will be going through at their advertised prices.

Let’s start with Twitter and what might happen.  There are a few scenarios:

  1. The $54.20 acquisition price happens.
  2. The price is renegotiated lower.
  3. The deal is called off by either Twitter or Musk and then the lawyers fight over money.

In case 1, the stock goes up 35%.  In case 2, the stock may only go up 10%, 15%, 20%, or some other amount.  We wouldn’t know until the new deal price is announced what the upside is for Twitter.  In case 3, the stock likely falls, as the acquisition odds drop to 0 and there’s no longer the clear upside from that element.  I don’t know how far the fall could be, but a fall to $25 per share would not surprise me.

Given this, I can look for ways to play a defined risk trade for the stock to be acquired for something between $45 and $54.20 in the next 3 months.  I’ll lose money in scenario 3, but if I believe that they are more likely to figure out a way to make a deal than not, I can make an options trade.  The September 2022 $40 calls are $5.00, and if I were to buy those, a deal at any price over $45.00 makes me money.  That’s one way to play it, and of course, there are many more complex strategies that could increase my leverage even more.

We could run through a similar analysis for Kohl’s, using a $60 target acquisition price as the best-case scenario for them, a lower price as a possibility, and no acquisition as a third possibility.  In that case, perhaps an October 2022 $45.00 call for $6.50 makes some sense.

In any case, you can see the general analysis from a stock that won’t trade off normal conditions, but rather has an event-driven gap coming.  If you can break down the possible scenarios and make sure you give yourself enough time to let the results play out, you can often find something potentially profitable, and then start working on tweaks to improve your odds even further.

If you’d like to learn more, please go to http://optionhotline.com to review how I traditionally apply technical signals and probability analysis to my options trades.  As always, if you have any questions, never hesitate to reach out.

Keith Harwood