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Jared Woodard Deal Analysis and Potential Options Trade: SYY

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When Sysco (SYY) announced plans last December to acquire its next-largest rival, US Foods, shares jumped nearly 10% on a closing basis. The stock has traded lower since then as customers and state attorneys general have filed antitrust complaints with the Federal Trade Commission, giving up about half of the gains from that deal-triggered jump.

In a story on Wednesday for The Deal, Bill McConnell walks through some of the key concerns that have been raised, many of which are based on a report from the advocacy organization Food & Water Watch. Critics cite the near-monopoly power that a combined Sysco-US Food entity would have over the hotels, universities, senior centers, and other customers that it services; additionally, they worry that the company would be large enough to force price concessions from farmers and other suppliers, harming competition.

There are two issues investors in the stock should consider. The first is whether, as The Deal notes, "the FTC will view the deal simply as one that affects numerous local markets across the country or one that also affects a truly national market." If the latter interpretation prevails, anti-trust arguments about the potential for monopoly power would seem to have more force. If the former interpretation prevails, SYY has committed to divest itself of local businesses worth $2B in annual sales if so required. But even that might not be enough: one Barclays analyst cited $6B as the annual revenue value of the divestitures that would be required.

The options market is taking these risks to the deal in stride: implied volatility has fallen steadily this year across every maturity, and sits now below the levels from before the deal was announced. Excluding dates involving deal news, earnings, or dividends, options on SYY typically trade around two thousand contracts per day; since 2014 began, volumes are also off somewhat.

Some of this is a reasonable reaction to recent trading activity: in realized terms, SYY volatility is extremely low. One month price volatility of the shares has averaged around 15% over the past few years, but in 2014 that figure is down to just 8.5%. Given how quietly the shares are trading now, April and May options trading at 12-15% are arguably fully priced.

But given how reactive the stock was on December 9th, investors who already have a position should still consider hedging the risk of an adverse FTC ruling. Investors can buy May $33 puts for $0.20 and sell April $36 calls for $0.30, generating a net credit and a free downside hedge if shares trade sideways or lower over the next few weeks.

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At the time of publication, Jared Woodard held no positions in the stocks or issues mentioned.

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