Name That Trade $VZ – Bad Reception

by Enis September 9, 2013 12:37 pm • Commentary

Verizon’s monster deal to buy the rest of Verizon Wireless from Vodafone is one of the largest acquisitions in the past 10 years.  The potential $130 billion deal is about half cash and half stock.  As Verizon turns to banks for financing the cash portion of the deal, Wall Street is licking its chops.  The banks are currently preparing a road show for one of the largest corporate debt sales in history.

Verizon’s price action since the deal was announced has been quite interesting.  Here is the short-term daily chart of the stock:

Daily chart of VZ, Courtesy of Bloomberg
Daily chart of VZ, Courtesy of Bloomberg

I’ve circled the date of the deal announcement in green, when the stock initially gapped higher to near the $49 level (which was prior support), but ultimately sold off hard from there.

The wireless business is THE driver of growth for both VZ and T, as they continue to wind down their landline businesses.  So while the deal itself is likely an attractive business investment on the part of Verizon, the sheer size of this deal creates an obvious overhang for the stock going forward.  Besides the $60 billion of stock that Vodafone shareholders will receive (though the deal is not expected to close until early 2014), the corporate debt deal is more massive Verizon business exposure to investors across the globe.

As a result, the stock has been weak ever since the deal announcement day, as traders and investors digest the large moving parts.  However, at 18.5x earnings, with expected EPS growth of around 20% over the next 2 years, and a 4.5% dividend yield, VZ stock is certainly on the cheap end of the spectrum relative to the rest of the market.

Value investors are likely to get interested in the stock at these levels, despite the technical overhang.  Meanwhile, the technical overhang is likely to persist at least until the debt sale is completed (and likely for the rest of 2013, given the amount of stock used to purchase VOD).

Moreover, the implied volatility of the options in VZ have increased since the deal was announced, as more traders focus on the potential scenarios for the stock.  1 month implied volatility over the last 2 years:  

[caption id="attachment_30013" align="alignnone" width="600"]30 day implied volatility for VZ, Courtesy of LiveVolPro 30 day implied volatility for VZ, Courtesy of LiveVolPro[/caption]

So 1 month implied volatility is near 2 year highs, despite the fact that VZ has now sold off into an area where the stock saw a significant amount of shares change hands throughout 2012 (when the stock earned about 20% less than it is expected to earn in 2013).  That spike in volatility looks like a sale given the push/pull factors for the stock from a fundamental vs. technical standpoint.

Finally, large debt and share sale events, while they might result in some quick short-term moves like we’ve seen in the past couple weeks, are usually vol dampening events.  Since a large amount of bonds or shares are priced at the same time, the syndicate (the banks who support the deal) and other traders and investors are often willing buyers of the stock at the same level as the initial pricing.  While there will be no secondary share offering, the simple completion of the debt deal in VZ should be vol dampening as well.

With that in mind, here’s the structure:

VZ ($46.00) Sell the Oct18th 45/47 Strangle at $1.82

-Sell 1 Oct18th 45 Put at $1.09

-Sell 1 Oct18th 47 Call at $0.73

Break-Even on Oct Expiration:

Profits: between 43.18 and 45 and between 47 and 48.82 make up to 1.82, max profit of 1.82 between 45 and 47

Losses: Below 43.18 and above 48.82, with linear losses beyond those levels.

Trade Rationale:  This trade takes advantage of the elevated implied volatility to collect almost 4% of premium in VZ for the next 6 weeks.  Given the nature of the deal and the stock’s reaction since, we like the levels above for a high probability profitable trade.  Given the margin requirements for an outright strangle sale, this trade is only for those with sufficient margin and risk appetite to take on open-ended risk in both directions.