(Note: The author of this fundamental analysis is a financial writer and portfolio manager. )
Shares of Time Warner Inc. (TWX) could fall by nearly 20% based on analysis of betting in the options market. Doubts have been creeping into the market about whether or not AT&T Inc. (T) can successfully close the deal to acquire the stock for $107.50 per share as initially planned. AT&T had to already extend the transaction termination from October 23. Shares of Time Warner have already fallen by nearly 14% since October 20, and the options market is giving signs the deal will never get done with shares of Time Warner potentially falling to below $70. (For more, see also: Top 3 Companies Owned by Time Warner.)
There is a lack of interest in trading of calls going out as far as January 2019, and this speaks to a market not willing to even place bets on the deal getting done. It seems strikingly odd that arbitrage players are not scooping these options up. It is likely the market's way of saying the deal will not close.
Lack of Enthusiasm
By January 19, 2018, $100 calls only have an open interest of about 29,000 contracts. While the $105 calls have approximately 15,000 contracts open, but further down the options chain the calls see surprisingly even less interest. The $90 strike price has only 5,000 contracts open, and trading at a price of $3.35 per contract, the calls just need to trade above $93.50 to break even. That implies nearly $14 in gains per contract should the deal ultimately get done. But yet, open interest at that strike price is tepid.
The options in January of 2019 show the same lack of enthusiasm. The $90 calls are trading at a price of $5.00, which again imply a breakeven price of $95, and a potential gain of nearly $12.50 per contract should the deal get done, but again there are only 199 contracts of open interest at the $90 strike price. (For related reading, see also: Time Warner CEO: AT&T Deal Was About Competing With Facebook, Google.)
The options set for expiration January 19, 2018, have overwhelming bearish bets placed that shares of Time Warner have further to fall. The $90 puts have nearly 42,500 contracts of open interest and are trading at a price of $5.20, which would mean shares of Time Warner would need to fall to below $85 just to break even. There are more bets being placed further down the option, all the way to the $70 strike, with nearly 22,000 contracts of open interest at a value of roughly $0.40 per contract, which implies a break even price of $69.60.
The bets being placed in the puts carry a high degree of risk, but a risk that could have a significant pay off should the deal fall through. Should the merger be completed at the purposed deal price, the value of those options falls to zero. But the odd piece here is that betting in the calls is not nearly as heavy as the puts, which again has to make one suspicious of the deal getting done at all.
The options market appears to be saying the deal for AT&T and Time Warner will not happen.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.