Merger Arb oppty with Penn National Gaming

If you are interested in side stepping some of the recent market volatility with a short-term merger arbitrage strategy, why don't you roll the dice with the pending merger transaction of Penn National Gaming Inc (PENN)....

The recent shareholder approval on December 12th, 2007 provides on more step closer to closing the deal.

On June 15, 2007, Fortress Investment Group LLC and Centerbridge Partners, L.P made a merger offer to PENN. Under terms of the deal, if the acquisition is complete by June 15, 2008, shareholders will receive $67 per share. If it closes after June 15, the price will increase by about 1.5 cents per day.

If you are unfamiliar with this strategy, please read my first merger arb post with MRK/RNAI for some background.

Here is the 1 year chart on PENN, currently trading at $59.65 per share at the December 12, 2007 close.




Details of the trade:

Purchase 419 shares of PENN for $25,003 including $10 in commissions. At $67 per share, this trade will provide you a gross return of 12.3% with your money working for about 6 months.

Closing Date Annual Percentage Rate Scenarios

May 15th, 2008: 27.8%
June 15th, 2008: 23.2%
July 15th, 2008: 21.2% includes 30 days of 0.0149 per share

(based on a 350-day calendar)

Author Disclosure: I do not own any shares of PENN or FIG. This strategy is highlighted for entertainment purposes for my mock short-term portfolio.


Sources:
Company website
SEC Edgar website
Yahoo Finance

Home Depot / Lowe’s Pair Trade beats S&P performance

That was a perfect up and down for the duration of the HD/LOW pair trade….about 10 days. To provide you a background, here is my first post on the Home Depot (HD) and Lowe’s (LOW) pair trade that I initiated as of the close on August 31st.

As my first post highlights, the target price ratio for the pair was 0.873 (LOW/HD). On September 10th, the pair closed at a ratio of 0.880; HD at $33.81 and LOW at $29.76, resulting in a 3.6% return after commissions in 10 days. On an APR basis, this trade results in a 131% return, not too bad.

Over the same period, the S&P 500 performed at a –1.5% loss from 1,473.99 to 1,451.70, therefore the pair trade provides alpha on an net basis (after commissions and taxes).

Final Trade details

Opening Trades:
Sell Short 261 shares of HD at 9,999
Buy 322 shares of LOW at 10,001

Closing Trades:
Buy to Cover 261 shares of HD for 8,824
Sell 322 shares of LOW for 9,583

Total Profit, gross $756
Commissions of ($40)
Profit, net of commissions $716

I have attached an updated version of the price ratio chart through September 14th, 2007.




I will continue to look for additional opportunities to initiate this trade again….

Please leave a comment or email me if you have executed this trade successfully.

Author disclosure: I am neither long nor short HD or LOW

HD/LOW Pair Trade

As the blood runs in the streets for the housing market, the current Home Depot (HD)/ Lowe's (LOW) pair trade offers your portfolio a hedged opportunity.

Before I get into the details, Exhibit 1. is a company overview comparison chart.

Exhibit 1.

I would also like to include the latest analyst price targets for both companies, Exhibit 2. sourced from Yahoo Finance.

Exhibit 2.

The current stock price ratio for LOW/HD is 0.811 ($31.06/$38.31)

The current mean analyst price ratio target is 0.873 ($37.31/42.73)

In Exhibit 3, I have plotted the LOW/HD stock price ratio on a line chart. You will see that this ratio was just recently at the mean analyst price targets of 0.871, but has dropped to the 20-day average.

Exhibit 3.

In my opinion, I feel this is a good opportunity to enter in a pair trade up to the pair ratio reaches the mean analyst price target of 0.873 ratio.

Here are the details of the paper trade:

Buy 322 shares of LOW at $31.06 = 10,001

Sell Short 261 shares of HD at $38.31 = 9,999

This is a cash neutral hedge with the cash outflow on the LOW purchase and the inflow on the HD short sale.

If this trade is successful, it will provide a +4.1% return after commissions. I will calculate the annual percent rate when I exit the trade.

Disclosure: Author is neither long nor short HD or LOW.

NTRI Covered Call Final Results – Post 3 of 3

As anticipated from my second post in this trilogy, my NTRI Covered Call strategy resulted in 30% loss protection strategy against a buy and hold approach.

Just in case, here are the first two links for the entire NTRI Covered Call Trilogy

Post 1
Post 2

On August 17th, NTRI closing stock price was $49.61. This represents a –22.2% decline vs. the stock price before the earnings release, the day I initiated the NTRI covered call strategy. If you were to execute this trade, you would have minimized your loss by 30%.

Buy and Hold Strategy
Buy 500 shares on July 24th, 2007 at $63.78/share
Value of holdings at close of day on August 17th was $24,805
Total Loss of -$7,095 or –22.2%

Covered Call Strategy
Buy 500 shares on July 24th, 2007 at $63.78/share
Sell 5 Aug 07 Call Options at $4.25 each
Adjusted Basis for Call Option Premium incl. Commission costs of $59.59/share
Value of holdings at close of day on August 17th was $24,805
Total Loss of -$4,990 or –15.6% from original purchase

If you have been successful with this strategy, please email me ....

Disclosure: Author does not own any securities, NTRI equity or options, mentioned in this article.

NTRI Covered Call Opportunity – Post 2 of 3

I initiated my NutriSystems, Inc (NTRI) covered call strategy on July 24th, 2007, before the company announced Q2 2007 earnings. This post is Post 2 of 3 regarding this trade. Part 1, which was posted on July 18th, described the setup of this short-term opportunity for existing long-term shareholders of NTRI, here is the link…. The earnings release was not well accepted by the Street, setting up a potential 670 incremental basis point gain* for the long-term shareholder.

After the bell on 7.24.07, NTRI announced their earnings for Q2 2007. Here is the link to the press release...link

Please note this strategy was highlighted for the long-term shareholders of NTRI, a group I am not a part of because of my value selection criteria.

Paper Trade Details:
- Long-term shareholder currently owning 500 shares valued at $31,890 ($63.78/share) at the close of 7.24.07
- Sell 5 August 07 call options with a 65 strike price for $2,125 ($4.25/share as of 7.24.07)
- $2,125 represents a 6.7% gain*.

Why did I choose the 65 November calls?
In the research that I published during my first post, I am using the 18-day % gain/(loss) from the last three reported quarters of an expected stock price gain of 1.3%. This results in a potential share price of $64.64 (1.3% above 63.78) at the date of option expiration on August 17th. I then take the next highest strike price of $65 to determine which strike price to sell, because I am trying to avoid the option be exercised. This trade does run the risk if the shares trade at the 18-day max levels, but most options buyers will wait to the last couple days to expiration to execute.

On August 17th, I will post the final part of this trilogy when the final results are in…

* Does not includes fees and taxes

Disclosure: Author does not own any securities, NTRI equity or options, mentioned in this article.

The Nutrisystems, Inc. covered call “schnitzel”

With the upcoming NTRI Q2 2007 earnings announcement on July 24th, there might be an opportunity to capture some call option premium dollars if you are long the stock.

3 reasons to consider writing a covered call on the pre-announcement date of July 24th, 2007:

- Although revenue growth is still positive and strong, it is on a downward slope
- NTRI option premium are rich driven by the historical volatility
- Analysts are getting better at forecasting this growth company, providing a smaller opportunity of significant upward revisions.

I have followed NTRI for a year and a half now and I am in kicking myself for missing this exploding stock. If you read one of my older posts, you will see that this stock does not fit my in with my value selection criteria. But with that said, I do see an upcoming opportunity to capture an option premium for all of the faithful longs.

If you are not familiar with NTRI, here is a link to my previous post on the background of the company….

Here is an updated chart of what the stock has done since my last post….

Exhibit 1.


Also, here is a chart that I have created plotting the historical quarterly revenue % growth vs. stock price. This is a great picture highlighting the accelerating revenue growth that you wish all of your stocks can achieve. In Q4 2005, revenue growth vs. prior year story peaked at 784% with the latest quarter (Q1 2007) coming in at 62%.

Exhibit 2.

In Exhibit 3, you will see that the analysts are expecting the growth to continue to drop to a level of 10-15% during 2008


Exhibit 3 .

From here, I wanted to see the reaction of the stock during these earnings announcements and will there be any opportunity to place an option bet to capture some value. There will be 18 trading days from the close of July 24th (earnings date) and when the August 08 contracts expire. Here are the last 11 earnings announcements and the performance.

Exhibit 4.1 – Dataset

Over the entire dataset of eleven 8-K earnings announcements, the stock has traded an average of +13%, with a max of +19% and a minimum of –0.1%. But before “backing up the truck” to buy call options to maximize profits, look at the last three quarterly results:

18 Day average of +1.3%, with a maximum of +6.8% and a minimum of –3.3%.

Exhibit 4.2 – Graph of results

To me, this range provides small opportunity to buy any calls or puts. But knowing the historical volatility of the stock, a long holder of NTRI might want to consider a covered call option strategy to capture some additional value by selling a call 5-10% above the July 23rd close price before the earnings announcement.

I will revisit this trade on July 23rd and provide you some a "mock" trade that I would put into place for my fake portfolio.

Author disclosure: I do not own any shares of NTRI

Sources:

SEC Online
Yahoo Finance
Morningstar.com

Company website

Merck/Sirna Merger Arb results in 8.4% APR

As you may previously recall, I entered into a merger arbitrage trade position for my short-term mock portfolio with Merck (MRK) and Sirna Therapeutics. Here is the link to the original post... MergerArb#1.

On Friday December 29th, 2006 Merck & Co., Inc. announced that it has successfully completed the acquisition of Sirna Therapeutics, Inc. in a cash transaction which closed in the fourth quarter of 2006. This date was 3 days later than my projected bull case.

Trade results in a profit after commissions of $125 or 8.4% APR.

Disclosure: This strategy is highlighted for entertainment purposes for my mock short-term portfolio.

Merck/Sirna acquisition provides merger arbitrage opportunity

Here is a merger arbitrage opportunity for my short-term portfolio. The players are Merck & Co. (MRK) and Sirna Therapeutics Inc. (RNAI)

The reason I am entering into this short-term trade for my are as follows:
- Successful completion of anti-trust filings
- Very minimal risk in not obtaining RNAI shareholder approval
- Annouced closing date range of late December 2006 to early January 2007 provides nice short-term window.

On December 14th, 2006 Merck and Sirna announced that the federal regulatory antitrust waiting period has expired for Merck's $1.1 billion acquisition of Sirna. The Hart-Scott-Rodino anti-trust waiting period is one of the major hurdles that an acquisition most overcome to close successfully. As this deal passes this hurdle, I see only one other major hurdle, Sirna (RNAI) shareholder approval.

Looking at the original terms or the acquisition, what shareholder would say no to this transaction...

On October 30th, 2006...Merck agreed to pay $13.00 per share in an all cash transaction for Sirna, that is a 102% premium that Merck ponied-up for this deal. Also, as in most merger stock charts, you will see that the price has been pegged around the $12.90 range since the announcement. This is primarily driven by all of the merger arbitrage trading that Sirna is experiencing, resulting in a higher probability of shareholder approval.



If you are unfamiliar with merger arbitrage, there are many variations. Here is the definition of what my trade is trying to accomplish:
A merger arbitrageur looks at the risk of the merger deal not closing on time or at all. Because of this slight uncertainty the target company's stock will typically sell at a discount to the price that the combined company will have when the merger is closed. Merger arbitrageurs care only about the probability of the deal being approved and how long it will take the deal to close.

Here are the details of the trade:

Purchase 1,933 shares @ 12.93 for $25,003 which includes $10 commissions.
Upon deal closing, this trade will provide a profit of $125.30 or 0.5% profit.
I know this return is not very exciting, but I am in the investing game to capture a slight edge, and this is it.

Depending on how many days it takes for the deal to close, it will impact your Annual Percentage Rate calculation. Here are 3 scenarios

Bull Case - Deal closes on 12/26/2006 yielding an APR of 11.4%
Base Case - Deal closes on 01/05/2007 yielding an APR of 6.0%
Bear Case - Deal closes on 01/15/2007 yielding an APR of 4.0%

Please note, APR calculations are based off of a 250-day calendar.

Disclosure: I am not long RNAI. This strategy is highlighted for entertainment purposes for my mock short-term portfolio.

Cha-Ching – The unwinding of the pair trade

"I love it when a plan comes together" as Hannibal frequently mentioned on the A-Team….

It only took 2 trading days for my pair trade goal to be met with a 72% annualized return before taxes. Here is the link to my pair-trade setup post:

A Perfect Pair Trade from Down Under

As expected, the price ratio fell within my goal on the ex-dividend date of IAF. Looking at the last 30 days of price ratio, you will notice the significant drop, similar to the previous quarterly dividend payment of IAF. The new price now falls below the 5 and 10 day moving average, along with falling in between the 2nd and 3rd quartile of the last years trading averages.



I was able to capture a net profit of $144 in 2 days, not including taxes. This results in a 72% annual percentage increase on my $25,000 investment, using a 250-day year. My profit before fees was $458 less $(40) for commissions and $(274) for dividend payments. You can improve this return by minimizing you per trade commission rates. I am using E*Trade as the basis. I have been recently informed that Bank of America will not charge you trading fees if you open an account of $25,000 or more, this would improve my return to 92%. Something to think about if you will be active with pair trades.....




If you have any other interesting pair trade setups, please feel free to email me the setups.

A Perfect Pair Trade from Down Under

Along with my passion around finding those great long-term stock prospects, I enjoy executing various hedge and arbitrage strategies. In this post, I would like to highlight a pair trade opportunity that is too good to pass up.

Before I get started, I would like to level-set for everyone. Pair trades are one of the strategies commonly used by hedge funds. The idea is to buy a stock that is expected to perform well and short another stock in the same industry which is expected to underperform. When selecting this strategy, I prefer to use ETF's and/or stock funds to get this as close to market neutral as possible. I typically perform this strategy to try and capture dividend risk free in a short time frame. As I was scanning to find a stock that is on ex-dividend in the next week or so, I came across IAF.

Aberdeen Australia Equity Fund, Inc. (IAF) operates as a closed-end, nondiversified management investment company. It invests primarily in equity securities, consisting of common stock, preferred stock, and convertible stock of Australian companies. The fund’s investment portfolio comprises various sectors, such as consumer discretionary, consumer staples, energy, financials, industrials, materials, property, telecommunication services, and utilities. Aberdeen Asset Management Limited serves as the investment advisor of the fund. Aberdeen Australia Equity Fund was founded in 1985 and is based in Plainsboro, New Jersey.

Dividend Yield of 9.0% - Very Attractive
Ex-Dividend Date on 11.30.2006
Dividend per share of 0.32 per share paid quarterly

From there, I look for IAF's perfect match, a stock/fund or ETF that is highly correlated with the Australian stock market...As I go to Yahoo Finance and scan the available ETFs, there in the distant awaits EWA. You have to love the new world of exchange traded funds.

iShares MSCI Australia Index (EWA) seeks to provide investment results that correspond generally to the price and yield performance of publicly traded securities in the Australian market, as measured by the MSCI Australia index. The fund uses a representative sampling strategy to try to track the index. The index consists of stocks traded primarily on the Australian Stock Exchange.

The next step is to plot the ratio of the two symbols. I've captured the historical daily close prices adjusted for dividends, for the last year of trading from the Yahoo Finance historical quotes section. Here are some of the key statistics of the pair:

Correlation of IAF / EWA is 89.6%
I prefer to keep this range in the 80-90% range. To mitigate risk, you should elect this number to be closer to 100%, which also impacts the amount of profit that can be captured.

Price Ratio Averages of IAF divided by EWA (adjusted for the upcoming dividend on 11.30.06)
1 year 0.597
10 day 0.605
5 day 0.608

Min 0.558
Median 0.594
Max 0.653

The rationale:
Over the last year, IAF has paid a hefty dividend yield that attracts many shareholders to buy and/or hold through the ex-dividend date. Right after the ex-dividend date, there is a higher amount of selling of IAF relative to its peer EWA. The chart below highlights the price ratio of IAF/EWA through the last 4 dividend dates from IAF.

Here is the daily price ratio for the last year with the ex-dividend dates highlighted in yellow circle.


Zooming in closer, here is the same data for the last month.


As of 11.28.2006, the price ratio is .611. Since the latest price ratio falls between the 3rd and 4th quartiles of the annual range, I will elect to short the ratio. Shorting the ratio entails the following trade:

Portfolio Size: $25,000

Opening Trades:
Purchase 535 shares of EWA at $23.38 per share worth $12,500
Short 856 shares of IAF at $14.60 per share worth $(12,498). I am entering IAF at a pre-dividend price because I will be paying out the dividend of 0.32 per share since I am short the stock.

When I enter these trades, I plan on unwinding the pair trade once the price ratio falls withing the 2nd and 3rd quartile. In this instance, my goal is for a price ratio of .607 or lower. Assuming I exit the trade in 5 days at .607, I get an annual APR of 38.5% on a 250 day basis. When I count in a $9.99 per trade commission fee, I get to a 22.5% return before taxes applied to my short-term capital gains.

Stay tuned for the results of this pair trade........

Disclosure: This strategy is highlighted for entertainment purposes. I am neither long IAF nor short EWA.