The clock is ticking on Yahoo (YHOO, $26.59, down $0.71) to accept Microsoft’s (MSFT, $29.73, down $2.07) bid. The deadline is Saturday and we’re likely will see some high action drama. The stakes are high for both sides but the real pressure is on Yahoo which really has no other options.

If Microsoft doesn’t get a deal done the company could go “hostile” with its bid. A takeover is considered “hostile” if Yahoo’s board rejects the offer and Microsoft continues to pursue the deal or if Microsoft would have made a bid without informing Yahoo’s Board beforehand then it would also have been considered a hostile takeover bid.

So what does this all mean? Yahoo’s isn’t opposed to a merger but wants a higher price. Both companies reported less-than-stellar earnings results so there is no leverage there on either side. Microsoft has said it will not raise its offer and Yahoo wants a higher one. It looks like its going come down to who’s word is the strongest and I’d go with Microsoft.

If that happens, then Yahoo could fall below $20. If Microsoft pulls out or goes hostile its stock could also slip as well. Here’s where it gets really interesting. The put volume in Yahoo is exploding and we are only halfway through the trading session.

Take a look at the action in the Yahoo May Puts:

May 25 Put (YHQQE, $1.04, up $0.40) up 63%, 32,000 contracts traded
May 22.50 Put (YHQQX, $0.54, up $0.24) up 70%, 16,000 contracts traded
May 20 Put (YHQQD, $0.24, up $0.12) up 100%, 23,000 contracts traded

Before I close, let’s throw this out there. What if Microsoft pulls out of the deal sending Yahoo’s shares down below $20? If that were to happen the stock could fall even further to the low to mid-teens where Microsoft could then aggressively buy Yahoo’s shares in the open market for half the price.

I can’t wait to see how this all unfolds.

Rick Rouse
Rick@OptionsMentoring.com