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However, if for some reason, there was a problem with financing this deal - as actually did
happen - this position would have made you a lot of money. Let's see what happened to
the stock. You can see the graph below here. We traded sideways until about mid-September,
when there started to be rumblings about the deal itself.
With the financial crisis came a crunch to Dow's cash position. Some rumors came out
that they didn't have the cash that they thought they were going to have to close this deal.
By October 10, there were some rumors that the deal would not close at all.
Let's go to October 10, and you can see that a profit of $1240 could have been made on
this position. It wasn't really that much of a risk, because prices on Roman Has could
only have gone to about $78, unless the shareholders didn't approve it, and Dow came back with
a higher bid. That was the primary risk of purchasing a put.
However, given the economic circumstances, and the fact that the stock was trading only
$2 away from the agreed-upon price that the board members had approved, it wasn't too
risky to purchase a put, at the time. That's one scenario. If you do see those coming through
like this, and you see a stock being bought out, and it's very close to a buyout price,
purchasing a put as a total risk speculation and trade is not a bad idea, in that kind
of environment.
In this case, it worked out to be a fantastic trade. Another potential equity partner, the
Kuwaiti Investment Authority, was also going to be part of the deal, along with Berkshire
Hathaway. In mid-December, they bowed out of the deal, citing cash restraints on their
position. They could not participate.
You can see that what happened was that Roman Has stock dropped, from a high of about $74.75,
all the way back down to a low of about $47. At that point, if you took a look at this
on December 29, you can see that the volatility had risen, because of this disappointing news
that the Kuwaiti Investment was going to drop out of this deal. The volatility had risen
to 166.8%.
It seemed to me, at the time, that the stock was all the way down, trading near its average
level for the entire previous year. If, for some reason, Dow was actually able to pull
this purchase off, the stock is still valued at $78. That's exactly what Dow had offered
to buy it for. Taking an opportunity to look at some potential trades here, I said that
166.8% implied volatility - the last thing you would want to do is buy an over-inflated
call. This is because of the high implied volatility.
The best thing to do, if you really wanted to play this deal, was to purchase what is
called a synthetic stock position. A synthetic stock position is simply - if you believe
the stock is going to advance, like I did, then what you do is buy a call and sell a
put at the exact same strike price. What this does is essentially give you a totally neutral
Theta. It also gives you a Delta of 100, almost exactly the same as buying the stock outright.
For each call that I purchased, instead of a Delta of 53, by selling the put at the same
strike price, I have given myself an additional Delta of 46.24, making this position almost
exactly the same as buying 100 shares of the stock. At the time, 100 shares of the stock
would have cost about $5300. By using this tactic, the margin requirement was less.
I thought the risk on the downside was minimal. The reason for that was that we were already
trading in this area of the $45, $50, which was the same price the stock had been trading
in for the previous entire year. The risk really was fairly minimal. If it dropped below
the lowest price of the previous year, about $45, it would have been easy to get out of
this position. Because I was only buying two options at the time, at two different strike
prices, monitoring it was a piece of cake. It was very simple. Again, simplicity is incredibly
important for trading strategies.
Let's see what happens as time progressed. That was on December 29. The very next day,
Roman Has went higher. We went to January, and Roman Has is now at $61.79. We have close
to $1000 profit on the position. Within just a few days, we had a profit of just over $1130
on the position, by having these two positions open.
At that point, you could have taken profits. This is how I would attack a stock if I thought
it was going higher after a tremendous down-move, and it had extremely high volatility. When
we got into the trade, the volatility was over 160%. Without paying too high a price
because of the inflated premium, due to the inflated volatility.
It's a great way to trade. It's equal to - and it also has the risks - of being long the
stock. If the stock did continue to fall, you would lose a dollar for every dollar that
Roman Has continued to decline.