Earlier today (below) I discussed some recent consolidation chatter in the auto industry. While it could seem a bit “pie in the sky” or “top of the market” the potential reasons make sense as it is my belief that the ground is quickly moving below the established U.S. automakers feet. M&A or partnerships will be done out of fear of an increasingly uncertain future given quickly advancing technologies that have the potential to turn the more than century old industry upside down. Its also important to remember that this industry in the U.S. was bankrupt six years ago resulting from a financial crisis………is there a perfect storm lurking?? Maybe the combination of a global recession, increased competition by locals in growth areas like China, and electric or driver-less upstarts like Tesla and Google getting a few things right.
As I stated earlier, short dated at the money options prices in GM are approaching all time lows since its late 2010 IPO, which has been accompanied by low levels of realized volatility in the stock and low levels of vol in the broad market:
For those who think bold moves are coming in the auto industry in the form of mergers or joint ventures, and GM will be in the middle of it, 30 day at the money implied volatility in GM options (Blue line below, the price of options) are as low as they have been, well ever, making long premium directional views attractive in place of stock, despite very low levels of realized volatility (white line below, how much the stock has been moving):
So the conundrum for those who want to have long exposure is whether the short term fundamental/macro risks outweigh the recent consolidation chatter. To be fair, the way in which GM CEO was approached by the FIAT CEO seems nothing short of odd, and lacks credibility, but if you are the type who thinks “where there is smoke there is fire” it may make sense to define your risk to express a bullish view over the next few months.
The chart below plots 30 day at the money implied vol (white line) vs 90 realized vol (green) which is just above 20, for those looking to take a 3 month directional view, the Sept 36 calls (stock reference $36.13) are offered at 1.55, at a 22% implied vol, not exactly expensive to the 90 realized:
So short dated options are fairly cheap, longer dated a tad less so, but that is a time thing and that’s what you will need to have a trade of this sort to play out.
I am not chasing GM after the stock’s recent bounce, but if I were to do so, this is how I would do with defined risk:
Potential Trade: GM ($36.13) Buy Sept 36 call for 1.55
Break-Even On Sept Expiration:
Profits: above $37.55, or up about 4%.
Losses: up to 1.55 between 36 and 37.55, with max loss of 1.55 at 36 or lower, or about 4% of the underlying stock price.
Rationale: The stock is trading essentially at the mid point of the 2015 range between $33 and $39, and frankly feels to be in no mans land. $35 appears to be important near term technical support, the level it was straddling prior to the m&a chatter:
This trade essentially stops you out right below the breakdown level.
Again this is not exactly my cup of tea, but if I were to play, options prices are cheap enough to warrant long premium trades with an eye towards spreading on a move higher.
Original Post: MorningWord 5/29/15: If Winter is Coming for the Auto Industry, Options Prices Don’t Reflect Fear
Last night on CNBC’s Fast Money we discussed media reports that General Motors (GM) had rebuffed a recent overture by Fiat Chrysler’s CEO to merge, watch here:
The idea may sound insane after what has been one of the most tumultuous periods for the auto industry in decades, and co-panelist FM Karen Finerman highlighted the fact that mega-auto mergers have had a checkered past, most notably Daimler Chrysler’s which was the largest cross border deal ever up until 1998. Is the notion of a mega-merger a tad “bull market”?? Well the rationale may be more focused on the next bear market, or possibly attempting to get in front of the largest secular shift in the automobile business, possibly since its inception over a century ago, where it appears the technological focus is quickly moving away from engines running on fossil fuels and towards microchips and batteries. Electric and driver-less cars may appear to be Jetson-esque sort stuff, but its apparent that some of the smartest technological minds of our times have set their sites on it (Elon Musk, Larry Page and even the peeps in Cupertino).
If I were an investor or a c-level executive in the auto industry, knowing that just 6 years ago the entire U.S. auto industry for all intents and purposes was a ward of the state, I would be focused on the next downturn and trying to be well positioned for a global recession and or the potential of upstarts like Tesla (TSLA) to massively disrupt the existing status quo. The cost structures for GM and Ford are way to high (given the breadth of offerings) to combat another crisis like we saw in the last decade, and with competition from local competitors in growth regions like China, the timing of such merger musings could make sense in an effort to dramatically cut costs.
As for GM, the stock has massively under-performed the S&P 500 since its late 2010 IPO, the SPX is up 80% since, while GM is flat, ugh. For those who think bold moves are coming in the auto industry in the form of mergers or joint ventures, and GM will be in the middle of it, 30 day the money implied volatility in GM options (Blue line below, the price of options) are as low as they have been, well ever, making long premium directional views attractive in place of stock, despite very low levels of realized volatility (white line below, how much the stock has been moving):
Its my sense that any consolidation in the auto industry will not be done out of position of strength, but likely the fearful foresight of industry execs who see the ground moving quickly below their feet.