M& A activity on the move?

Kraft announce a takeover for Cadbury recently and as usual Krafts price dropped substantially - $28.10 on 4th Sept and $26.45 on the 8th Sept - around a 6% drop in price.

Meanwhile back at the ranch ...

I put on an ATM Sept PUT calendar in Heinz (HNZ) and you guessed it - given Cadbury's reluctance to be taken over, all the other alternative food conglomerates have shot up in price. Heinz in particular shot up from it's dozy sideways path at $37.80 on the 4th up to $39.92 on the 10th - a 5.5% rise driven by the Kraft takeover.


Interestingly, my calendar has made greater than 10% in less than 10 days and the question is where is HNZ going as far as price is concerned?

Over the next few days there is an expectation of further good economic news but counterbalancing this for HNZ is that how much upward pressure can be maintained on it's share price when it is not part of the Kraft M&A deal - the HNZ increase in price I feel is over zealous traders buying the rumour and over the next days they will sell the fact and HNZ will retrace.

And so Tonto, what's happening back at the ranch - what does this mean for my Calendar trade?

Well right now the price hike in HNZ coursesy of the Kraft deal, has cause my calendar to be under stress but still up good money (11% in about 4 days)

If the market pulls back after the news of the Kraft action is digested and calmer markets prevail, I will make an even higher return. However if the economic news on the budget and the Kraft action continues to stimulate the market my profit will vapourise.

As this is a September trade and I usually plan to exit on the friday before expiration, I think I will take my 11% and sit back on the porch and drink lemonade over the weekend.

Cheers

Delta & IV balance - which is best?

The following RUT Iron Condor has been constructed based on Deltas of between 6-7 points. The aim is to run the trade for 36 days with no adjustments & target the 12% potential ROI.

This trade is constructed with short deltas of 7 for each side, thus the probability of success in the trade between now and expiry is around 86%. (100%- 2*7 deltas). In fact, You can calculate the probability of remaining between the upper and lower standard deviation marks off the risk chart (35.7% + 32.2% = 68% or 1 standard deviation). In addition this trade has a yield of 12% (potential profit of $660 / $5,340 margin = 12%). Not bad for a monthly return.

The trade has the 1 standard deviation bands marked on the risk chart and the issue here is that the trade has much more room to the downside at execution. We received $1.10 credit for this trade and we could increase the upside width or keep the full $1.10 on the basis that the market has appeared to be over bought for some time now and many traders are expecting a retracement to lower levels. In this case keeping the full $1.10 and leaving the trade with greater downside capacity would seem logical.

So what is more important when constructing the trade - Implied volatility as indicated by the standard deviation range or the probability of success as calculated by the 7 point delta range?

Cheers