This Stock Could Be the Biggest Winner in the Qualcomm-Broadcom Deal
Broadcom is attempting to buy Qualcomm and this week increased the amount it is willing to pay. In its latest offer, Broadcom continues to offer Qualcomm shareholders $60 in cash per share but raised the stock portion of its bid to $22 worth of Broadcom shares from $10.
“Qualcomm and its board now have a tough decision as this is a compelling offer in our opinion,” said analyst Daniel Ives of GBH Insights.
The offer does include several sweeteners for Qualcomm shareholders. Broadcom said it was willing to increase the cash part of the deal if the transaction is not completed within a year and would pay Qualcomm a significant “reverse termination fee” if regulators veto the deal.
Broadcom could pay a break-up fee of up to $10 billion to Qualcomm, CNBC reported citing sources.
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Qualcomm said it would review the revised proposal and will have no further comment on the proposal until its board has completed its review.
Fallout From the Deal Affects a Third Company
As part of its strategy to remain independent, Qualcomm has been seeking a deal with NXP Semiconductors NV (Nasdaq: NXPI). Qualcomm has offered $110 per share for NXPI but the deal has not moved forward since the original announcement.
NXP shareholders had held up a deal, saying it undervalued the company and had sought a price as high as $135. If Qualcomm accepts Broadcom’s offer, it would have to drop the NXP bid as it is unlikely that NXP shareholders would accept the original price.
That sets up a potential move in the shares of NXPI. The stock has been trading above $110 a share for some time.
If the Broadcom deal goes through, Qualcomm’s bid for NXPI would go away and it is likely that the price of NXPI could fall if that happened. If Qualcomm pursues a deal with NXPI to fend off Broadcom’s offer, it’s likely they would have to increase their bid and the stock price could rally.
A large price move in NXPI appears likely as news of the deals in the industry is finalized. However, there is no way to forecast the direction of that price move.
A Long Strangle Benefits From a Large Move
The long strangle involves buying an out of the money call option and an out of the money put option, both with the same expiration date. This strategy can be used when a significant move in a stock is expected. This strategy can benefit from a large move, without requiring the trader to form an opinion on the direction of the trade.
Like all options trading strategies, the long strangle is limited by time because all options have an expiration date. This strategy can be implemented when earnings are due since the date of that event is known. It provides potential gains based simply on the move.
The strategy hopes to capture a quick increase in implied volatility or a big move in the underlying stock price during the life of the options. The risks are known when the trade is opened and the potential gains can be large. This is shown in the diagram below.
Source: The Options Industry Council
A Specific Trade in NXPI
NXPI is trading near $120 a share. An out of the money call is one that has an exercise price above the current price of the stock. An out of the money put has an exercise price below the current price of the stock.
For NXPI, a strangle can be created by buying an $121 call and an $119 put, both expiring on Feb. 16. The call is trading at about $2.40 and the put is trading at about $1.40.
To open the trade, a total of $380 will be required since each contract covers 100 shares. This example ignores commissions because they should be quite small, just a few dollars, at a deep discount broker. When trading options, it will be important to select a broker that offers very low commission rates.
NXPI is likely to move to either $110, the price that Qualcomm as offered to pay for the company, or to $135, the price shareholders of the company believe they should receive in a buyout.
Of course, other prices are possible, but using those price targets, we can review the possible outcomes of the trade.
Assuming NXPI falls after the news, it could reach the down side target of $110. At this price, at expiration, the call option would be worthless. The put option would be worth at least $9. Since the trade cost $3.80 to open, this would result in a profit of $5.20 per contract for a return about 35% based on the amount of capital required to open the trade.
On the other hand, if NXPI rallies on the news to the price target of $135, the put option will be worthless. The call option would have a value of at least $14, delivering a gain of $10.20 per contract based on the amount of capital required to open the trade. That represents a gain of more than 160% for a trade that will be open for about two weeks.
This return would be for a short term investment trade. If trades like this could be found once a month during earnings season, the potential gains on the amount of capital required to open a trade would be rather large over the course of a year.
The risk of the trade is limited to the amount of money paid to purchase the two options. Even if NXPI fails to make a large move, the size of the loss could be smaller than the amount invested assuming one of the options retains some value.
When news points towards potential volatility, the long strangle strategy offers a way to benefit from volatility rather than attempting to make directional calls on trades. This could be appealing to risk averse investors who understand the difficulty of forecasting short term price moves.