Declines Create Bargains
It is possible there will a boom for investment bankers in a bear market. Investment bankers include the deal makers on Wall Street and as stocks decline, there could be an increase in take overs as bankers find value in targets that have been on their watch lists.
There could be the case for a deal in one beaten down stock already, Zayo Group Holdings, Inc. (NYSE: ZAYO). The stock is trading higher on rumors and could offer an excellent short term trading opportunity.
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Low Prices Offer Bargains
As detailed by Bloomberg, Zayo Group Holdings Inc. attracted takeover interest from a group of investors including funds managed by Blackstone Group LP and Stonepeak Partners LP, according to people with knowledge of the matter.
Funds managed by KKR & Co., I Squared Capital, GTCR and Charlesbank Capital Partners are also part of the group that has expressed interest in a take-private deal for Zayo, said the people, who asked not to be identified because the details aren’t public.
Shares surged as much as 20% on the news.
There’s no guarantee a deal will be reached and the company, which operates an almost 130,000-mile fiber network across North America and Europe, is currently focused on its announced plan to split into two parts, two of the people said.
Representatives for Zayo, KKR, Stonepeak and Blackstone declined to comment. Representatives for I Squared, GTCR and Charlesbank didn’t respond to requests for comment.
Shares jumped on Friday after Cowen & Co. analyst Colby Synesael wrote in a note to clients that a takeout offer was likely. Including debt, the company is valued at about $11.1 billion, according to data compiled by Bloomberg.
Zayo, which went public in 2014, announced on Nov. 7 that it plans to separate itself into two publicly traded companies — one focused on communications infrastructure and the other on enterprise services.
Daniel Caruso, the CEO, co-founder and chairman, is slated to lead the infrastructure group, which may later convert to a real estate investment trust structure for tax purposes, Zayo said. He owns 8.6 million shares or 3.6 percent of the company, according to data compiled by Bloomberg.
As it announced the split on Nov. 7, the company also disclosed third-quarter earnings that fell below analyst expectations. Its shares had fallen 22 percent since then and were down 36 percent for the year through Friday.
Activist investment firm Jana Partners LLC owns 1.7 million shares, or 0.7 percent of Zayo. Jana reduced its position in the company by about 415,000 shares during the quarter ended Sept. 30, according to data compiled by Bloomberg. But, Jana could still push for a deal.
A Trade for Short Term Bulls
As with the ownership of any stock, buying ZAYO 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 priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for ZAYO
For ZAYO, the December 21 options allow a trader to gain exposure to the stock.
A December 21 $27.50 call option can be bought for about $1.20 and the December 21 $30 call could be sold for about $0.60. This trade would cost $0.60 to open, or $60 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 $60.
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 ZAYO the maximum gain is $1.90 ($30 – $27.50 = $2.50; $2.50 – $0.60 = $1.90). This represents $190 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $60 to open this trade.
That is a potential gain of about 316% 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.