My job was to write shell code to perform Unix admin jobs and C code to improve the trading model. I also had to write a program that would ring a bell at night to wake the night trader when she had to trade.

The portfolio model took the mean returns of all the possible instruments and their variances and tried to build a portfolio that would maximize the return with the smallest possible variance. No one likes a big variance in return. One program I worked on extended this to the skew and kurtosis of the currencies. I also wrote a program that got these different moments of the distributions from the option series for the currencies and bonds that we traded.

The traders called the banks to get the best prices for the currency contracts that the program told us to buy. We had Reuters to tell us what the market was at any time, but the trades were done over the phone.

Mergers create special situations for traders.

The premium you get for selling options is larger if the distribution is wider.  The wider the distribution, the more the stock price varies.  So you want to sell the widest distributions only if the risk warrants it.

Two Separate Peaks

Since there is a possibility that the merger doesn’t go through, there are two widely separated peaks to the probability distribution of the stock price.  One peak is centered on the price distribution for BUD as a stand alone company, the other peak is near the price the acquirer is willing to pay for the company.  The purchase price is usually above the market price of the stock, to entice shareholders to part with their shares.

Because there are these two peaks, that makes the option look like an option with a very fat distribution.  That makes the premium very high.  But you are paid for the possibility that the merger doesn’t happen and the target, BUD in this case, falls back to its original price.  Then you will be put with the stock.  If it looks like the merger is going through while your option is decaying you earn a good premium.

So it is safest to do this early in the process, before there might be funding problems or the acquirer feels buyer’s remorse for paying too much.

BUD

On November 4 and 5th I sold some BUD options for $1.45 and bought them back November 12th for $0.55.  This was before I set automatic stops to buy in the options.  Still a good return for a week’s exposure.

To get a free CD with more options income strategies, click here watch the video,  and add to cart.