Options traders betting on Time Warner takeover facing losses
Fox's cancellation of bid for Time Warner leaves options dealers with soured bets
Many options traders who had taken bets on a successful buyout of Time Warner by Rupert Murdoch's Twenty-First Century Fox are facing a grim lesson in the risks of betting on deals.
Murdoch pulled the US$80 billion offer after the close of trading on Tuesday, saying Time Warner management had refused to engage in discussions.
He also cited the sharp drop in Fox's share price since the proposal last month, saying it "makes the transaction unattractive to Fox shareholders".
Time Warner shares fell about 10 per cent to US$76.80 following news of the offer's withdrawal, while Fox's stock gained about 9 per cent.
Expectations that Fox would raise its bid to at least US$90 a share and even above US$100 had prompted traders and investors to put down a series of bets.
There are more than 25,000 out-of-the-money call option contracts expiring in mid-October that anticipate Time Warner to close at between US$90 and US$105 a share.
There are more than 12,700 outstanding contracts that bet on Time Warner shares to close above US$92.50 by mid-October. Just after the Fox bid, those options surged to trade at a peak of US$3.09.
Since then hopes of a deal had diminished as Time Warner made it clear it did not want to talk to Fox about a deal.
The mid-October options closed on Tuesday at US$1.20. If a trader had bought all those contracts at the peak, the cost would have been about US$3.92 million. They are now worth about US$1.52 million and the value is expected to drop further.
Randy Frederick, a managing director of trading and derivatives with the Schwab Centre for Financial Research, said that if Time Warner shares were to drop about US$10, the mid-October options would likely see their value fall to about 10 or 11 US cents.
"You're looking at a 90 per cent drop in value," Frederick said. "Unless they got those positions before the announcement, they probably paid a lot and were looking to get a small gain."
There are also plenty of positions expiring this month and next month that are in danger of turning into losers.
More than 17,000 call options contracts in Time Warner that expect a close above US$85 currently trade at US$1.65 per option - and they expire next week. At their peak, those contracts would have cost US$6.89 million and are now worth about US$2.81 million.
At least one asset manager who bailed on the stock before the announcement said Time Warner looked too pricey at the Fox offer price of US$85 a share.
"We compared Time Warner to Netflix and Amazon and felt it was way too rich in terms of valuation," said Diane Garnick, the chief executive of asset management firm Clear Alternatives.
Her company sold the stock last week.
One event investor, commonly called arbitrageur, said he was relieved he had avoided the temptation to get in on the buy-Time Warner-sell-Fox trade after Fox's offer was first made public last month.
"Lots of event and arb funds had the long Time Warner and short Fox trade on. I don't think many avoided it," the investor said.