Goldman sees more focus on M&A in U.S. options market

*Options are being used to position for M&A

*M&A potential is far from “priced-in” to candidates

*GS: buy calls, sell longer-dated options on six stocks

CHICAGO, Dec 17 (BestGrowthStock) – Investors seem more comfortable
using options to position for potential mergers and takeovers
this year with the U.S. economic backdrop that is supportive of
deals, Goldman Sachs strategists said on Friday.

“We see an increased focus on M&A in the options market,”
GS equity derivative strategists wrote in a research report.

The increase in M&A options speculation has been signaled
in particular by short-dated options trading at a premium to
longer-dated ones on companies that were acquired last year.

That pattern, known as term structure, is still relatively
modest as positioning ahead of potential deals is not rampant,
the strategists said.

The Goldman strategists said the trend is also highlighted
by a lower skew, meaning call options are well bid compared to
put options among companies considered to be takeover targets.

After an announcement, the skew tends to move higher as
investors are generally long stock and look to puts to hedge
their downside risk in case the deal does not close.

An equity call option grants the right to buy shares at a
fixed price any time until expiration while a put conveys the
right to sell the shares at a fixed price up to a certain
date.

“While investors appear more comfortable trading M&A
expectations with options, it is our view that M&A is far from
‘priced in’ across the board,” the strategists said.

Exceptions where M&A seems more priced into options are:
Low-cost wireless carrier Leap Wireless International (LEAP.O: )
Inc, baby formula maker Mead Johnson Nutrition Co (MJN.N: ),
network equipment maker Brocade Communications Systems Inc
(BRCD.O: ) and data storage equipment maker NetApp Inc (NTAP.O: ).

“After M&A announcements, volatility tends to fall sharply,
especially for longer-dated options,” the strategists said.
This makes selling long-dated options attractive, while large
average stock moves of 30 percent following a deal announcement
supports owning calls, the report said.

The strategists recommend trade ideas on Internet content
delivery company Akamai Technologies Inc (AKAM.O: ), mining
equipment maker Joy Global Inc (JOYG.O: ), drugmaker Allergan Inc
(AGN.N: ), U.S. energy exploration company EOG Resources Inc
(EOG.N: ), satellite television provider DirecTV Group (DTV.N: ),
and EMC Corp (EMC.N: ) a maker of corporate data storage
equipment.

Goldman sees 15 percent or greater probability of M&A
activity in all of these stocks and has positive stock views
outside of M&A expectations.

The strategists recommend buying short-dated calls, while
selling longer-dated options such as so-called strangles to
trade M&A potential that is not being adequately reflected in
the options market. The strangles best help investors capture
volatility and stock patterns around M&A.

A strangle is a strategy consisting of calls and puts with
different strike prices but with the same expiration date.

“If M&A does not materialize, these trades are designed to
perform well if the bullish fundamental views from our analysts
materialize,” the strategists said.

But embarking on such trades have risks in that the
acquisition does not play out. For example, call buyers risk
the premium paid.

(Reporting by Doris Frankel, Editing by Chizu Nomiyama)

Goldman sees more focus on M&A in U.S. options market