Options Head to Zero as Time Warner, Sprint Bets Collapse

Options traders who were trying to profit off three proposed mergers saw the value of their bets vanish yesterday.

Fifteen different series of Time Warner Inc. contracts lost more than 90 percent after 21st Century Fox Inc. withdrew its $75 billion takeover offer, sending the stock down 13 percent. The two options on Sprint Corp. with the highest ownership were valued at a penny each after the company ended talks to acquire T-Mobile US Inc., while options betting that Walgreen Co. shares would rise as much as 18 percent by tomorrow were almost wiped out.

Options traders and arbitrageurs who piled into wagers that the deals would be completed suffered as the stocks tumbled. Almost $27 billion in market cap was erased from the value of Time Warner, Sprint, Walgreen and T-Mobile, data compiled by Bloomberg show.

“Any time you see a big drop in share price or mergers falling apart, calls that were trading before are worthless,” Tim Biggam, chief options strategist at TradingBlock, a brokerage firm at the Chicago Board Options Exchange, said by phone. “Once the deals start to fall apart, it gives everyone pause about the next deals.”

The Chicago Board Options Exchange’s Volatility Index rose 1.8 percent to 16.66 at 4 p.m. in New York. Its European counterpart, the VStoxx Index, jumped 8.6 percent to 20.79.

Board Refused

Fox dropped its proposal to buy Time Warner, citing that the company’s board had refused to engage in talks and Fox’s stock price had declined since the offer became public, according to a statement from the company. Time Warner plunged 13 percent, the biggest drop since 2008, to $74.24.

Bullish calls that pay off should Time Warner shares reach $85 by Aug. 16 dropped to 1 cent yesterday from $1.65. Open interest, a measure of the number of positions that have been created, increased to about 17,000 contracts, compared with 18 before market open on July 16.

Other Time Warner options that tumbled included $84 and $85 contracts that expire tomorrow. Prices for both fell 99 percent yesterday. The five most-owned Time Warner calls, all expiring in August or October, fell more than 88 percent.

“Ouch!” Andrew Wilkinson, chief market analyst at Interactive Brokers LLC, said in a research note. Fox abandoning its bid for Time Warner “is not what event-driven call buyers wanted to hear having locked-in to bullish bets,” he wrote.

Most Active

Puts on Time Warner shares expiring on Aug. 16 with a strike price of $72.50 were the most actively traded. The price jumped to 68 cents yesterday from 3 cents.

Sprint stopped talks to acquire T-Mobile, a person with knowledge of the matter said, as regulatory concerns outweighed the potential benefits. The decision capped a nine-month effort by Japanese billionaire Masayoshi Son, whose SoftBank Corp. controls Sprint, to create a rival to Verizon Communications Inc. and AT&T Inc. T-Mobile sank 8.4 percent to $31.06.

Shares of Sprint tumbled 19 percent to $5.90. The options were hit harder. The cost of $8 calls expiring Aug. 16, the contract with the highest ownership, dropped to 1 cent. It traded at 90 cents at the beginning of July.

Bearish wagers with a $6 strike price expiring Sept. 20 were the most-traded Sprint contract. The price rose to 53 cents from 10 cents.

Higher Taxes

Walgreen, the biggest U.S. drugstore chain, said it plans to pay about $15.3 billion for the part of Alliance Boots it doesn’t already own, and won’t use the deal to move its tax address abroad. The company had considered redomiciling in Switzerland to lower its tax rate and has come under political pressure not to do a so-called tax inversion. The stock lost 14 percent to $59.21 for the largest drop since 2007.

Six Walgreen calls expiring this week with strike prices ranging from $65 to $70 lost 99 percent of their value. About 88,000 options betting on a decline in the shares changed hands yesterday, the most in almost four years.

“Given that spreads and returns in the area have generally been difficult to generate, these developments are particularly painful,” Keith Moore, an analyst at MKM Partners LLC in Stamford, Connecticut, wrote in a note to clients.

Money managers tracked by the Hedge Fund Research HFRX Event-Driven Index are up 3 percent this year, trailing the S&P 500’s 3.9 percent gain. The gauge rose about 14 percent in 2013, a year when the S&P 500 rallied 30 percent for its best year since the 1990s. The firm’s merger arbitrage index has climbed 0.4 percent in 2014.

“If you want to dabble with fire, you sometimes get burned,” Robert Pavlik, who helps oversee $4.5 billion as chief market strategist at Banyan Partners LLC in New York, said in a phone interview. “If you’re an investor trying to make money doing merger arbitrage, this is the risk you run.”

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