After Eight Months, This Deal Could Be On Track
The announcement is the first step in a takeover. Then, there is a regulatory review and that process can involve a number of regulators in a number of countries. Each review can take time and the regulators will often address different concerns.
As the number of regulators and the complexity of the review process increases, the time between the announcement and the closing of the deal increase. Because deals can take time to close, there are opportunities for investors.
A Long Delayed Deal Could Be on Track
Last October, wireless chip vendor Qualcomm (Nasdaq: QCOM) announced it will buy diversified chip maker NXP Semiconductors (Nasdaq: NXPI) for $110 per share, or $47 billion, vowing to “create a semiconductor engine for the connected world” for the mobile, automotive, Internet of Things, and networking markets.
As the chart below shows, the level of volatility of NXPI has been rather high, unexpectedly high for a company expected to deliver $110 to shareholders when the deal closes.
Now, analysts believe Qualcomm is getting closer to completing its deal to buy NXPI. One analysts with that opinion is RBC Capital’s Amit Daryanani according to Barron’s.
Qualcomm was forced last month to refile its application to China’s MOFCOM, the last regulator in the world that has still not blessed the $47 billion acquisition.
Media reports recently indicated China has re-opened its review of the deal, after what seemed to be U.S. President Donald Trump seeking concessions from China for his hard line stance on tariffs and trade.
Daryanani, who has an Outperform rating on the stock, and a $70 price target, noted that China has approved Toshiba’s $18 billion deal to sell its flash manufacturing unit to a consortium of investors led by private equity shop Bain Capital.
He added that deal appeared that the deal was about to fall apart because of the regulatory standstill.
“We think the probability for QCOM/NXPI deal to get MOFCOM approval has improved over last few weeks given,” writes Daryanani.
The uncertainty around the deal has led to increased volatility in the stock as the daily chart of the stock below shows.
Volatility tends to increase the premiums of options and that creates a trading opportunity for options traders.
A Trade for Short Term Bulls
As with the ownership of any stock, buying NXPI could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for NXPI
For NXPI, the June 15 options allow a trader to gain exposure to the stock.
A June 15 $120 call option can be bought for about $3 and the June 15 $125 call could be sold for about $0.85. This trade would cost $2.15 to open, or $215 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $215.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in NXPI the maximum gain is $3.70 ($125 – $120 = $5.00; $5.00 – $2.15 = $2.85). This represents $285 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $215 to open this trade.
That is a potential gain of about 170% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.