In January 2022, Microsoft announced the acquisition of Activision Blizzard(ATVI) at a price of $95 per share.
Microsoft’s offer is for $95 in cash, notwithstanding that Microsoft can change the offer, the price is viewed as fixed. This is because there is no share offer component. With Activision trading at $78.38 as at close on 1 Jul 2022, one will start to wonder if there is a merger arbitrage opportunity.
The reason for the merger arbitrage opportunity is that the deal is pending approval from regulatory bodies. Hence there is a probability that the deal may not be approved in its entirety or at all. Warren Buffett’s Berkshire has taken a 9.5% stake in ATVI, betting that the deal will be approved, however he has acknowledged that the investment could result in losses should the deal not proceed.
Here we will share a few ideas on how to leverage on this opportunity, utilising options to enhance the range of potential trading returns.
Before we talk about the idea, let’s lay out a few assumptions:
1) Trade timeframe of 1 year
At the point of offer, Microsoft has previously communicated the targeted timeline is for the deal to close by 30 June 2023. In May 2022, the company has also mentioned that the deal is “moving fast”. Hence we will use 30 June 2023 as the timeline for the deal, meaning this trade will have a timeframe of 1 year.
2) Option strike price of $75
In this case, when we looked at the range of option strike price, we identified that the strategy with the lowest total downside impact is when the option strike price is $75. In this case, it is the closest strike price to the current share price, but we have to highlight that this may not always be the case. To derive the total downside impact, we factor in the cost of the option together with the difference between the strike price and the share price.
For example, a put option with a strike price of $75 means that the maximum possible loss per share is $3.38 as there is an option to sell the share at $75. Coupled with a put option price of $6.60, the total cost is $9.98.
3) The possible share price range for ATVI is $56 to $95
To estimate the lower end price range of ATVI, assuming there was no deal on the table, we take into consideration the Nasdaq index which has fallen 30% this year and ATVI’s beta of about 0.55. (Source: Yahoo Finance).
The beta of the stock is a concept that measures the expected move of the stock relative to movements in the overall market. For example, if the Beta is 0.5, if the market gains 10%, the stock would gain 5%. If the beta is 2.0, if the market gains 10%, the stock would gain 20%. ATVI’s beta is 0.55 which indicates an expected move of 11% if the market moves 20%.
We note that ATVI’s share price as at 31 December 2021 was $67. Therefore, if ATVI had fallen in line with the Nasdaq Index, relative to its beta it would have declined to approximately $56. Hence for this example, we will set ATVI’s potential trading price range to be between $56 and $95. Based on this price range, it is clear that there is both upside and downside, hence the trade is not riskless and there could be substantial losses.
Of course one may take a poorer view of ATVI and expect its share price to fall more than the market’s performance as it has been involved in ongoing lawsuits relating to poor human resources practices which has an adverse impact on the share price.
Hence before we present the ideas, we have to reiterate that this is merely for discussion purposes and not an inducement to trade.
Buy/Sell Microsoft?
We would not trade Microsoft as the acquisition offer is not very significant to Microsoft. Moreover Microsoft is able to fully fund the acquisition with cash on hand, that is to say, Microsoft would not need to take on additional debt or carry out an equity fund raising.
Buy/Sell ATVI?
Potential Strategy #1 Buy ATVI Stock
If we buy ATVI stock outright with the view that the probability of the deal completing as higher than the odds of the deal falling through, the potential upside would be $16.62 or 21.2%, should the deal fall through, assuming no other variable has changed, the downside would be $22.38 or 28.6%.
Potential Strategy #2. Buy ATVI with options
Now this is where it gets interesting, while there are many variations of this strategy which could provide different returns, we will assess the potential returns by executing this trade with a simple protective put strategy.
For the strategies involving options, we use the moomoo platform to illustrate the scenarios.
The protective put strategy involves purchasing the stock and buying a put option to protect the downside.
With the deal expected to be completed by June 2023, we expect for Microsoft to receive the approval at least 3 months in advance, Hence, for illustration, we look at put options with the following details.
| Put option Strike price | Expiry date | Cost (Ask prices as at 1 Jul 22) |
|---|---|---|
| 75 | 20 Jan 2023 | 5.25 |
| 75 | 17 Mar 2023 | 6.60 |
We will select the put option with a strike of $75, expiring 17 Mar 2023 that will cost $6.60, as Microsoft may not have received regulatory approval by 20 Jan 2023.
This means that should the deal fall through and share price drop, our maximum loss per share would be $3.38 and combined with the cost of the put, total loss will be $9.98 or -12.7%.
Should the deal succeed, the maximum upside is now $10.02 or 12.8%, being $16.62 minus $6.60, as we have to pay for the put option.
For illustration purposes, if we are confident that Microsoft would receive regulatory approval earlier as Microsoft has mentioned that the deal is “moving fast”, we would buy the put option expiring 20 Jan 23 as Microsoft may receive regulatory approvals by then. The maximum loss would then be $8.63 or -11.0% while maximum upside would be $11.37 or 14.5%.
Potential Strategy #3. Short ATVI
Similar to Strategy #1 but on the flip side, the potential upside would be 28.6% while the potential downside would be -21.2%.
Potential Strategy #4. Short ATVI with options
Similar to #2, but as the view is that the deal will fall through, the trade will be executed by shorting the stock and buying a call option. This is also known as a protective call strategy.
| Put option Strike price | Expiry date | Cost (Ask prices as at 23 June 22) |
|---|---|---|
| 75 | 20 Jan 2023 | 6.70 |
| 75 | 17 Mar 2023 | 8.40 |
Similarly, we select the call option with the expiry date of 17 Mar 2023 that will cost $8.40. Should the deal fail, the maximum upside based on the lower end of the potential trading price range of $56 would be $13.98 or 17.8%. On the flip side, should the deal go through, factoring in the strike price of $75, the maximum downside is $5.02 or -6.4%.
If we select January’s call option, the maximum upside would be $15.68 or 20.0% while the downside would be $3.32 or -4.2%.
Closing statement
Before selecting a strategy, one must first take a trading view based on the information presented such as the probability of the deal proceeding and the timeline in which it would complete.
| Strategy | Potential upside (%) | Potential downside (%) | Variance (%) |
|---|---|---|---|
| #1 Buy stock | 21.2 | -28.6 | -7.4 |
| #2 Buy stock + option | 12.8 | -12.7 | 0.1 |
| #3 Sell stock | 28.6 | -21.2 | 7.4 |
| #4 Sell stock + option | 17.8 | -6.4 | 11.4 |
Regardless of taking a long or short view, it is clear that by incorporating options into the strategy, the returns may be potentially enhanced as the upside is relatively higher than the downside. While it seems like potential upside is reduced, in investing, it is more important to manage risks and secure overall positive returns in the longer term.
For us, we would choose Potential Strategy #2 where buy we would purchase the stock and a protective put option as we believe the likelihood of the deal succeeding is higher. With this strategy, we would gain from the share price appreciation should there be news surfacing of regulatory approval and the deal proceeding. Should the deal not succeed, we can cap our downside loss.
For whichever strategy you choose, Moomoo provides a P/L analysis function which allows you to easily view the profit and loss payoff diagram.
If you’re thinking of generating an income stream with Options, join us at our Options Trading masterclass to discover how you can do it on your own.
【Path】
Stocks – Options – Chains – Detail Option Quotes – Analyses – P/L Analysis
For readers that are entirely new to options and find this interesting, Moomoo has a function supporting Paper Trading in option with $1million funds. We have embedded a few snapshots below with detailed steps showing how you can access the Paper Trading function.
【Path】
Step 1: Save the targeted option (ATVI230317C75000) in the Watchlist for later use.
Step 2:
⦁ Go to【Discover】-【Paper Trading】
⦁ Switch to 【Options】-【US Option Paper Trading】，Click 【Trade】
3&4. In the Order page：click【Hot Options】-【Watchlists】, choose the option you just saved in the watchlist
5. Modify order details and finish the placement
If you would like to trade options, you may sign up for an account with moomoo here!
*As options are complex in nature, please do your own research and due diligence and understand your own risk tolerance before executing any trades. This article is meant for educational discussion and is not an inducement to trade.
This article is brought to you by Moomoo Financial Singapore Pte. Ltd. The views expressed belong to the author. This article has not been reviewed by the Monetary Authority of Singapore.