Using the Options Market to Profit from Next Kraft Heinz Takeover - Cabot Wealth Network

Using the Options Market to Profit from Next Kraft Heinz Takeover

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You can learn a lot just from observing the options market. Ever since the Kraft Heinz (KHC) and 3G Capital bid to acquire Unilever (UL) was turned down, traders have been speculating on who will be the next target.

Just last week, two research houses wrote notes weighing in on whether General Mills (GIS), Kellogg (K), Colgate Palmolive (CL), Coca-Cola (KO), Pepsi (PEP) or others would be bought.

And last week, options traders aggressively bought Kimberly Clark (KMB) calls, likely playing a potential takeover. Here were those trades:

Buyer of 5,000 Kimberly Clark (KMB) July 145 Calls for $1.45 – Stock at 133.50
Buyer of 8,000 Kimberly Clark (KMB) July 150 Calls for $1.30 – Stock at 133.75

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What was so interesting about these trades was the way that the price of these calls skyrocketed when the trader started aggressively buying the July 150 Calls.

As I’ve written about before, volatility is a key component to the pricing of an option, and can be thought of in terms of supply and demand. If a big drug announcement or earnings report is coming, traders buy options to protect themselves. And when traders buy lots of calls/puts, the volatility/price of options moves higher.

For example, back when I was an options market maker on the Chicago Board of Options Exchange (CBOE), if an order came into my crowd to buy five Google (GOOG) January 840 Calls for $10, I would sell the five calls at the trader’s price and not think much about it because it was an easy order for me to hedge.

jacob photo-cboe

Jacob Mintz at the CBOE.

However, if a broker like Goldman Sachs wanted to buy 10,000 of the same calls, I wouldn’t sell 10,000 calls at $10. I would probably sell 100 calls at $10, then 500 at $10.50, 1,000 at $11, etc., with the price continuing to move up until I could fill the order. The volatility/price rose based on the demand.

Let’s take a look at the options market trades made in KMB last week, which is a great illustration of how volatility/price can move explosively higher.

On the left side of the table below, note that these trades were made between 2:08 and 3:27. On the right side of the table is the price of the stock throughout this timeframe. The stock essentially went up $0.60, which is not enough to move the July 150 Calls much because they are so far from the current stock price.

The options market is showing some interesting activity in Kimberly Clark (KMB). The table shows that the July 150 Calls were initially bought for $0.85, then went to $1.00, $1.30, $1.40, $1.45, and as high as $1.55 with the stock trading in a very tight range. Under “normal” conditions (when there isn’t a buying frenzy), with the stock up $0.60, I would expect calls to move approximately $0.04—not $0.70!

And the following day, with the stock down $1.50, the same calls were still offered at $1.50. Volatility/price had not yet pulled back because traders were still “gun shy” to sell these calls, fearing a takeover.

We often see this type of volatility move when a stock is perceived to be “in play.” Because the options market maker doesn’t want to sell thousands of calls into a takeover, he raises the price/volatility as high as he can so that they’re selling at “good” prices.

We also see this type of volatility/price movement when traders aggressively buy weekly options calls. Weekly calls expire each Friday afternoon, and often these options are targeted ahead of a news event because they are cheaper than “regular” options.

As I noted to my subscribers last week, a trader bought several thousand Astra Zeneca (AZN) calls on Thursday. This trader was targeting a move from 29.60 to above 30 in the following 36 hours. This was an odd trade.

Volatility/price spiked higher on the AZN options because market makers were likely thinking, “This is an odd trade. What does the buyer know? And how am I going to hedge this trade?” (The call buyer lost his entire premium as the stock closed just below 30 on Friday afternoon).

If you have any questions about this, consider taking a trial subscription to Cabot Options Trader.

For more information click here.

Jacob Mintz

Quick Profits, Controlled Risk

Jacob Mintz is a professional options trader and Chief Analyst of Cabot Options Trader. He uses calls, puts and covered calls to guide investors to quick profits while always controlling risk. Beginners and experts alike can gain from following Jacob’s advice.

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