One of our favorite stocks, Chesapeake Energy (CHK, $15.80, up $0.90), made the rumor mill rounds yesterday as there is speculation that British energy group BP PLC (BP, $42.70, up $1.92) is preparing a takeover bid. Man, don’t you love it when the M&A activity heats up?
We’ve been down the Chesapeake road before playing the stock both ways with call and put options. Some of you made 50%-75% gains when I profiled the November 25 calls back in October as the stock ran from $22 to $26.
Then, in December after the company came out with news that it was selling stock to raise nearly $2 billion in cash, we bought the December 17.50 puts. That trade was good for over a 100% return as the stock fell from $17 to $14. Whenever a company sells stock to raise cash, it dilutes shareholder value. Earnings suffer because there are more shares…it’s the perfect recipe to play a stock lower in most cases.
I haven’t mentioned Chesapeake too much since but the option activity had me looking at the stock again yesterday. Naturally, the rumors were downplayed by both companies as a BP rep said that they never comment on market rumors. Ditto for Chesapeake. If there are any serious discussions between the two companies going on, it’s between them and a fencepost right now.
The option activity is expecting something sooner rather than later. The February 17.50 calls (CHKBW, $1.00, up $0.45) traded 20,000 contracts while the February 20 calls (CHKBD, $0.45, up $0.30) traded 21,000 contracts.
The March 20 calls (CHKCD, $1.00, up $0.45) traded a little over 5,000 contracts. However, looking into the numbers, it has been reported that most of the call activity was done by someone pretending to be a Gordon Gekko clone.
Somebody bought roughly 13,000 of the February 17.50 calls and 15,000 of the February 20 calls. Wow! Basically, dude bet $65,000 to make $3 million. If Chesapeake can get to $21 on a takeover bid then this person is going to make a mint.
I’m on the fence with this one and I like the stock at these levels but the news is already baked into the option premiums. The stock would have to get to $18.50 by February 20th just to breakeven on the February 17.50 calls.
This is exactly where the first level of resistance is for the stock with more headwinds at $20 and $22. If there is no merger, Chesapeake would have to rally on fundamentals and that doesn’t seem likely.
Rick Rouse
Rick@OptionsMentoring.com
