How to Trade Verizon Now That the Yahoo Deal Is Done
Finally, Yahoo is part of Verizon (NYSE: VZ). The deal for Verizon to acquire Yahoo’s core internet business including the search engine, mail service and operations like Yahoo! News and Yahoo! Finance, was initially announced almost a year ago, in Jul 2016. Almost immediately after the deal was struck, problems began to surface. Perhaps the most important surprise came when Yahoo told investors that it had discovered two data breaches in 2013 and 2014. In total, the security breaches affected over 1 billion email and user accounts.
This news forced the two sides to reconsider the deal. In the end, Verizon decided to move forward after a price cut that accounted for the potential risks of the data breach. On Monday, the two companies finally completed the deal for $4.48 billion, $350 million less than the original offer of about $4.8 billion. Even after the discount, the deal demonstrates the high value of Yahoo’s site which is the sixth most visited web site in the world according to Alexa.com.
As part of the deal, Yahoo’s Chief Executive Officer (CEO) Marissa Mayer is stepping down. Mayer, who had been CEO of the company since July 2012, is expected to receive a “golden parachute” payment that filings with the Securities and Exchange Commission indicate is worth more than $23 million.
Mayer’s departure is expensive but frees the company to pursue a different path. Management has announced that Yahoo’s assets, which include popular Finance web site, will be combined with AOL brands such as the Huffington Post under a new subsidiary called Oath. It has already been announced that Tim Armstrong, former CEO of AOL, will head the subsidiary, which will now be home to more than 50 media and technology brands.
CNBC reported that Armstrong has been leading integration planning teams since the transaction was announced last year. In April, Armstrong named his leadership team. It’s an experienced team steeped in the culture of both companies. AOL president and former Yahoo executive Tim Mahlman will head advertising technology, Yahoo engineer Atte Lahtiranta will lead tech and Verizon’s Ralf Jacob will oversee digital media.
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The deal appears to make sense from a strategic perspective. Analysts have said Verizon’s acquisition of Yahoo is seen as a way for it to extend its reach to more consumers and boost its presence in the mobile and online video space against firmly entrenched giants in the industry including Google and Facebook.
It remains to be seen how the new company will perform financially. Costs will likely be cut and job cuts are widely expected to be a major part of that effort. There hasn’t been an official announcement but CNBC has quoted an unnamed company source as saying about 2,100 jobs will be cut as the companies fully integrate their operations.
Investors and analysts will most likely need to wait several weeks to learn more about integration plans, cost savings and the potential return on investment of the deal. Additional details will most likely be provided by management in their next quarterly earnings announcement and the call with analysts that follows that press release. There might not be a lot of news from Verizon until then and the likelihood of no news for several weeks sets up a potential trading strategy in shares of VZ.
Until news is released, it is likely the stock will trade in a relatively narrow range. Earnings are expected to be released in the week of July 26. It’s likely the stock will make a reasonably large price move after that. A calendar spread is an ideal strategy for this type of scenario.
Calendar spreads involve selling one option and buying another with the same exercise price but different expiration dates. Puts or calls can be used. To implement the strategy, a trader needs to determine the direction they expect to see prices move after the trading range is completed. To help make that decision, the chart below provides a weekly view of VZ with a stochastics indicator at the bottom of the chart.
The stochastics indicator is a momentum indicator and technical analysts use it to project the direction of potential price breakouts. Technical analysts rely on charts to make trading decisions and they believe momentum leads price. This means a momentum indicator should change direction before prices do. The next chart puts the indicator in the same area of the chart as the price action. This chart can be difficult to read but it does show the tendency of momentum to lead price.
Stochastics is now turning up and in the past, this been a signal to buy the stock. Stochastics indicates a long calendar spread should be used, with calls as the trading vehicle.
The trading range should resolve when earnings are released. This means we want to use one call that expires before the earnings announcement and a second one after the earnings release. We will want to sell a call that expires before the earnings release. The proceeds from that sale will reduce the cost of purchasing a call that expires after the release.
Specifically, the July 21 $48 call can be sold for about $0.21. This will result in a credit that can used to offset the purchase of an August 18 $48 call for about $0.42. The position is a debit spread costing $0.21. Since each contract represents 100 shares, the cost to open the trade is $21.
The maximum gain on this trade is theoretically unlimited while the maximum loss is the amount paid to enter the trade, or $21. This is shown in diagram below, taken from the Options Industry Council web site.
Let’s look at the possible outcomes for this trade.
The first date to consider is July 21, when the first option expires. If VZ is below $48 at that time, the July call will be worthless and you will not have to do anything. You will still own the August call which allows you to profit from a potential rally in VZ after the earnings announcement.
If VZ is above $48 at that time, the July call will be subject to exercise. The August call could be used to offset the position at that time. The position could be closed by buying the July 21 call and selling the August 18 call. This would result in a loss that is expected to be equal to $21, the amount paid to open the trade.
The second date to consider is August 18, when the second option expires. If VZ traded above $48 when the July option expired, this position would have been closed. If VZ was below $48 when the first option expired, there would be two possible outcomes for the August call option, a gain or a loss.
If VZ is above $48 on August 18, the call will be worth the difference between the stock price and the call exercise price of $48. At $50, you would be able to close the position by selling the call for $2 which would result in a profit of $1.79. At $55, the profit would be $6.79 after considering the $0.21 cost to open the position.
If, on the other hand, VZ is below $48 when the August option expires, the call would be worthless and the total loss on the position would be $21.
A calendar spread offers a way to benefit from the expected price action in VZ. The potential gains are large while the potential risk is relatively small. This is possible because the strategy sells a call to help offset the cost of buying a call with more time to expiration.
The strategy can be useful when there is a reason to expect both a period of calm and a breakout in a stock. That is the case with VZ which will need time to integrate Yahoo’s internet properties into its operations. There could be a trading range while investors wait for word on how the integration is proceeding. The earnings announcement could push the price out of the trading range. In this case, the chart tells us an upside breakout is likely. With those three pieces of information, a strategy can be developed as we did in this article.