How to Play an Acquisition Target with Options

03/18/2010 12:01 am EST


Harley-Davidson (HOG) was up all day on Tuesday on very active stock trading on buyout rumors that private equity firm Kohlberg Kravis Roberts & Co. (KKR) would acquire the company. 

Before you think about chasing the stock, let's take a look at what options pricing as of yesterday's close says about the likelihood and time frame of a buyout.

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March options expire Friday, so anyone trading those is guessing that a buyout will come within a 72-hour period.

The various call strikes traded 20,914 contracts versus an open interest of 7,318 contracts. The closest puts ($25 to $30 strikes) traded more than 13,500 contracts, while open interest was less than 2,000 contracts in the same strikes.

The bulk of the trading activity, though, was in the HOG April $27 to $30 call strikes, with 27,875 contracts traded versus a prior open interest of 10,384 contracts. The puts saw 17,000 contracts trade versus a prior open interest of 11,753 in the active strikes.

What Are Traders Telling Us?

First and foremost, the stock rose almost 7% to $28.34 on about five to six times regular trading volume of more than 18 million shares.

HOG's 52-week trading range is $10.86 to $30, and it has a market cap of more than $6.6 billion.

The stock and options trading here suggests that any merger deal is being given a very low premium considering it would be on top of today's 6.98% move up to $28.34.

The HOG April 28 calls (HOG   100417C00028000) closed at $1.65, and the HOG April 29 calls (HOG   100417C00029000) closed at $1.15. If you start averaging these out, and not take any time value into consideration for premiums, it becomes hard to believe that a buyout north of $30 is likely. 

HOG was a $40 stock in 2008, and was north of $60 in 2006 and 2007. Chances are that the company could not sell on the cheap regardless of last year's lows.

If you do believe the rumors, I'd go with speculative stock options rather than chasing the stock.

By Jon Ogg, contributor,

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