Like a kid at Christmas, I almost couldn’t sleep last night in anticipation of what Yahoo’s (YHOO, $28.67) stock will do this morning after Microsoft (MSFT, $29.24) bailed out of pursuing a merger over the weekend. I have been following the May put options on Yahoo for nearly two weeks through this Blog (for educational purposes only) and wanted to illustrate the volatility of taking positions like these without any protection or “hedging”.

April 25th

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

May 2nd

May 25 Put (YHQQE, $0.69, down $0.49) down 42%, 31,000 contracts traded
May 22.50 Put (YHQQX, $0.37, down $0.12) down 24%, 15,000 contracts traded
May 20 Put (YHQQD, $0.17, down $0.04) down 19%, 45,000 contracts traded

As you can see, these put options were profitable until Friday. That is when the rumor mill got rolling with news that Microsoft would be raising the premium for Yahoo. In fact, investors thought it was so much of a done deal that the stock was trading at $29.70 in after-hours trading meaning if things would have held to form these puts most likely would have expired worthless.

However, this wasn’t the case. Time decay was putting pressure on the May 20 and 22.50 puts as time decay starts to speed up in the last month of an option contract for out-of-the-money options. I’ll add an update around 10AM EST on the end of this post once Yahoo opens.

Rick Rouse