Scanning through unusual activity tonight, here I find something interesting. On Feb 23, 2010 at 3:12 pm EST, the CFO of United Airlines, Kathryn Mikells, openly expressed interest in merger discussions and further consolidation in the airline industry during a Reuters Travel & Leisure Summit in New York.
This reminded traders when in 2008 United Airlines was aggressively pursuing merger talks with Continental, Delta and US Airways. The CFO declined to comment when asked whether she meant merger talks was definitely back on the table, but that didn't stop at least one trader taking a shot in the option market.
Half hour after the presentation and 15 minutes before the closing bell, at least one trader bought large at-the-money straddles across all three names. Specifically:
US Airways (LCC) at 3:53pm EST: - Bought 7500 of Sept $7 calls for $1.6 (bid/ask $1.50 x $1.60) - Bought 7500 of Sept $7 puts for $1.7 (bid/ask $1.55 x $1.70)
Continental (CAL) at 3:46pm EST: - Bought 3000 of Sept $20 calls for $3.35 (bid/ask $3.25 x $3.35) - Bought 3000 of Sept $20 puts for $3.45 (bid/ask $3.35 x $3.45)
Delta Airlines (DAL) at 3:48pm EST: - Bought 3900 of Sept $13 calls for $2.1 (bid/ask $1.95 x $2.10) - Bought 3900 of Sept $13 puts for $2.45 (bid/ask $2.30 x $2.45)
As you can see, all orders were filled on the offer and the volume was more than 9x open interest. Total value of the combined trade is ~$6.3 million. Two things are clear here. One, with United CFO talking mergers, the implied volatility will remain sharply elevated and will probably get even higher as more analysts start the chatter. This will expand and benefit the straddle. Second, it is reasonable to assume that a merger with one airliner is an automatic loss for the other. Thus, a straddle on all three makes sense.
I like this set up and will buy all three straddles. But to further reduce the cost and avoid any damage from Theta decay, I'd be selectively selling front month out-of-money strangle each month where necessary. I will buy the above straddles when the market opens, and will inform my readers if and when I decide to sell strangles against the long positions.
This trade requires patience and management of your inventory of calls and puts each month, but the payoff could be huge depending on the outcome.
I have Masters in Business (Accounting and Finance 2003) from Michigan State University. I have been trading the market since 1998. Prior to picking up trading as a full-time career in 2008, I was a management consultant at Alvarez & Marsal and Conway MacKenzie for four years. I provided turnaround, crisis management and restructuring services to financially distressed firms. Prior to working in turnaround, I worked in Audit & Assurance at Deloitte & Touche for two years. Trading in the market has always remained my side business ever since I started college. 90% of the time, I trade through options. I love volatility skews and positive Theta plays. While I make a lot of directional bets, in general my favorites are to take advantage of high implied volatilities through calendar or butterfly spreads and vertical credit spreads. I never buy straight calls or puts and I do a lot of exotic multi-leg option trades.