New Trade $PYPL: Offsetting Payment

by CC September 11, 2015 11:42 am • Commentary

A few weeks ago we took a look at PayPal (PYPL) following its tax free spin from eBay (EBAY), read here. Our thoughts on valuation and competition from Aug 20th:

In PYPL’s Q2, (per the WSJ) the company “processed 1.1 billion transactions in the second quarter worth $66 billion; 22% of that, or $14.5 billion, came from eBay marketplaces. New active accounts rose 11% to 169 million. Revenue rose to $2.3 billion”.    In 2015, PYPL is expected to have $9.25 billion in sales, just a tad below the expected $9.76 billion for MA, and well below the $14 billion expected for V.  Yet PYPL trades at only 5x those expected sales with a market cap just below $45 billion, while MA trades 11x expected sales and V near 13x expected 2015 sales.   PYPL is the tech company with fast growing peer to peer payments App Venmo, and recently acquiring online money transfer service XOOM. What gives?

And our conclusion:

The stock is interesting and if we were to see it back towards the low of the 6 week range at $34 we would likely look to structure a bullish trade that targets a move back to the midpoint of the range ($38) over the next couple months, while also mitigating a decline in options prices. You guessed it, an in the money call butterfly, stay tuned.

Well the stock has come in since our post, and is now very near its all time closing low of $32.70 from Aug 25th:

PYPL since spin from Bloomberg
PYPL since spin from Bloomberg

The technicals for a stock with a mere 50 days of trading under its belt are fairly meaningless, and probably a better guide post would be relative valuation.  We made the case last month why the stock was cheap relative to peers, with the stock down more than 105 since, and estimates unchanged, its safe to say the stock is cheaper.

But one thing that has risen is options prices, despite realized volatility actually declining:

PYPL since July 30 day at the money implied vol (blue) vs realized vol (white) from Bloomberg
PYPL since July 30 day at the money implied vol (blue) vs realized vol (white) from Bloomberg

So if our concern was the price of options last month, we are even more concerned about expressing directional views with long premium strategies:

Implied vol is in the mid 30’s from September and out. It being such a new listing it’s difficult to guage where it goes from here. EBAY IV is about 10 points lower despite being both a smaller market cap than PYPL, and sporting a stock price 10 dollars lower (vol is usually higher for lower dollar, smaller market cap stocks) but this could be a reflection of both it being a new listing and it being in a more competitive market with tape bombs more possible. But one would think vol would come in slightly once the newly listed stock establishes more of a trading pattern.

The next identifiable catalyst for the company will be their second earnings report as a standalone company that should come in the last few days of October (yet to be confirmed by the company but Bloomberg estimates Oct 29th).

As for options, open interest is heavily skewed towards calls, more than double that of puts (121,000 vs 58,000) and today call volume is running hot with 9 of the 10 most active options calls with 15,000 trading vs 2,000 puts as of 11:30am.  The call activity is being attributed to take-over chatter from the likes of Google (per, which in our minds would make perfect sense.  Back in April we opined on the topic (Bid on $EBAY’s Paypal Auction):

Once the spin is done I can’t imagine PayPal is independent for too long, and if I were Google or Facebook I might strongly consider buying Paypal to meet the Apple Pay threat head on.

So what to do? We would look to sell short dated calls to help finance the purchase of longer dated calls for those that think the stock could be range-bound near term, but the potential for takeout is real into year end.

Trade: PYPL ($32.70) Buy Oct / Jan 35 Call Calendar for $1.25

-Sell to open 1 Oct 35 call at .95

-Buy to open 1 Jan16 35 call for 2.20

Break-Even on Oct Expiration:

-Max profit at $35, max risk of $1.25 with a sharp move above $35 or below current levels.

Rationale: The idea here is to sell higher short dated implied vol (the Oct 35 calls are 45% on the bid) and the Jan16 35 calls are 42% iv on the offer).

If the stock is $35 or lower on Oct expiration we will look to turn into a vertical call spread by selling a higher strike call in Jan16 expiration, or possibly turn into a diagonal calendar by selling a higher strike call in November or December expiration when they are listed.  The idea is to continue to whittle away at the long premium leg of the trade in January. But very importantly if you are in this sort of trade for a take-out which is likely a low probability event, its important to turn into a vertical or a diagonal as soon as possible to avoid being right on direction and wrong on trade structure. Regular readers know we are not fans of long premium directional strategies playing for low probability events when vol is high.