This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Plotting Your Plays on Takeover Targets

This column was originally published on RealMoney on Jan. 11 at 2:00 p.m. EST. It's being republished as a bonus for readers. For more information about subscribing to RealMoney, please click here .

Even as private-equity buyouts and corporate takeovers are occurring with increasing frequency and at record numbers, the ability to identify and profit from the next big deal remains as elusive as ever.

One of the most popular strategies is to use options, buying out-of-the-money calls on a slew of possible takeover candidates and hoping one gets a big premium bid and delivers jackpot returns. The problem is, just like the lottery itself, buying another fistful of tickets does not measurably improve your odds, but increases the likelihood of loss.

A better bet is to focus your attention, and dollars, on companies already in play, such as Harrah's (HET), or those that are courting suitors, such as Foot Locker (FL - Get Report).

It might mean lower returns, but it offers a much higher probability of turning a profit. And the last time I checked, consistent hitters Cal Ripken and Tony Gwynn are heading to the Baseball Hall of Fame, while slugger Mark McGwire will be riding the pine of shame into retirement. The obvious lesson is don't swing for the fences. Be patient and wait for a situation that offers not only a reasonable risk/reward, but also a quantifiable edge.

Collapsing Time Premiums

In options-trading (or any investing, for that matter), eliminating or accurately gauging the behavior of the price variables under a particular circumstance provides an enormous edge to controlling risk and increasing the probability of a profit.

It's crucial, and advantageous, to understand what happens to the option prices on a company once it agrees to a merger/takeover/buyout: Once a deal is agreed to, the implied volatility or time premium collapses. That is, options that are out of the money will be essentially worthless, and in-the-money options will be priced at their intrinsic value.

Remember, the bulk of an option's value stems from the right to buy or sell a stock at a set price -- the strike price -- during a given time period defined by the expiration date. Once terms of a deal are agreed upon, those variables are eliminated and so, too, is the price premium awarded to the options.
1 of 3

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
EAGL $9.66 -0.62%
FL $60.81 -1.10%
GPS $23.02 -2.20%
AAPL $93.53 -1.40%
FB $116.19 -0.46%


Chart of I:DJI
DOW 17,696.50 -134.26 -0.75%
S&P 500 2,054.78 -21.03 -1.01%
NASDAQ 4,750.4690 -54.8220 -1.14%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs