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A Cancelled IPO Sets Up a High-Income Opportunity

A Cancelled IPO Sets Up a High-Income Opportunity

Traders have been expecting a number of initial public offerings, or IPOs, this year. They have already seen some including poorly received offerings from Lyft and Uber. Now, traders are wondering how many more offerings they will see after some important news.

South China Morning Post reported some surprising news, “Anheuser-Busch InBev (NYSE: BUD) has scrapped what could have been the largest global initial public offering (IPO) of 2019 in Hong Kong, in a setback to the city’s plan to catch up with New York as the world’s fundraising hub.

“The company is not proceeding with this transaction due to several factors, including the prevailing market conditions,” Anheuser-Busch said in its announcement to scupper its US$9.8 billion IPO.

“The company will closely monitor market conditions, as it continuously evaluates its options to enhance shareholder value, optimize the business and drive long-term growth, subject to strict financial discipline.”

The decision came after the unit Budweiser Brewing Company APAC failed to price its IPO, which was expected to be offered at the lower end of a range of between HK$40 and HK$47 per share, according to a person familiar with the IPO, and a fund manager briefed by bookrunners of the deal.

According to its financing schedule, Anheuser-Busch had to price its Budweiser stock by the middle of July for the shares to debut on August 16 in Hong Kong.

Depending on the final pricing, Budweiser is potentially raising US$8.3 billion to US$9.8 billion from the listing, surpassing Uber, which raised US$8.1 billion in New York in May to become the world’s largest IPO this year.”

The news had an impact on Hong Kong, currently ranked third in global IPO rankings for stock exchanges.

Analysts noted that Anheuser-Busch has picked an inopportune time to tap the financial markets, as Hong Kong is still reeling from the aftermath of a controversial extradition bill, where thousands of protesters still take to the streets around the city, more than a month after 1 million people voiced their opposition in a mass rally.

The city, a financial hub for Asia and an entry point for mainland China’s massive consumer market, is also squeezed by the year-long US-China trade war, which has forced companies to defer and reconsider their expansion in the city.

But BUD faced other challenges.

“Global investors have subscribed for more than US$10 billion worth of Budweiser shares. Still, about 70 per cent of these orders are from hedge funds who bought at prices near the bottom end and tend to hold for the short term, according to a fund manager who declined to be named.

The remaining investors are global long-only funds. Chinese long-only funds have snubbed the offer in favour of Hong Kong-listed China Resources Beer, a brewing company headquartered in Beijing.

The lack of institutional support for the share has some investors worried that it may slip beneath its offer price during next week’s debut.

The offeror “wants to sell the share at HK$47 apiece, but the market sentiment seems to be inclining toward Hk$40 and that’s a huge discount,” said Louis Tse Ming Kwong, managing director of VC Asset Management.

The stock sold off on the news.

BUD daily chart

This could mark the end of the stock’s attempt to rally.

BU weekly chart

A Trading Strategy To Benefit From Weakness

A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.

In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.

Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.

One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.

Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.

The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.

bear call spread

Source: The Options Industry Council

While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.

You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.

Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

A Bear Call Spread in BUD

For BUD, we could sell an August 16 $85 call for about $4.23 and buy an August 16 $90 call for about $1.64. This trade generates a credit of $2.59, which is the difference in the amount of premium for the call that is sold and the call.

Remember that each contract covers 100 shares, opening this position results in immediate income of $259. The credit received when the trade is opened, $259 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $241. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($259).

This trade offers a potential return of about 107% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if BUD is below $85 when the options expire, a likely event given the stock’s trend.

Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $241 for this trade in BUD.