What’s the Best Way to Take Advantage of High Volatility in AOL?
The
Federal Communications Commission drew the line in the sand when they said
they’d have a decision on the America Online
(
AOL |
Quote |
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PowerRating)/Time
Warner Inc.
(
TWX |
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PowerRating) merger by December 31. Despite that commitment, it
seems more and more likely that the deadline will come and go without a
decision being made.
Volatilities, which normally trade in the 60% range, have surged to 90% due to
the uncertainty. My younger brother trades for us in the AOL pit, and he says
the appetite for the LEAPs is insatiable.
Those longer-term options are up even more than the near-term options and that
presents some interesting possibilities. For instance, the January 2002 are up
from 47% to over 58%, which is extraordinary. LEAP volatility movement is
normally much more muted. A 19% move in volatility there is like a 70% move in the near-term options, so it’s probably something worth focusing
on.
As a rule, we like buying the LEAP calls as a surrogate for stock ownership,
but since these LEAPs in AOL are up in cost substantially, we like the idea of
writing them, rather than buying them. For example, buying AOL for $35 1/8 and
selling the January 2002 40 calls for $7, looks awfully attractive. Our total
capital up is the net of the $35 1/8 less the $7 we get for selling the LEAP,
or just $28 1/8. If AOL is above
$40 in January one year from now, this covered write would be a huge winner.
At $40 we make 4 7/8 on the stock and the full $7 on the option, for a net of
$11 7/8 on a $28 1/8 investment. We like that kind of reward for owning what
will certainly be one of the best entertainment companies in the world.