Activist investors are either a sore on the backside of a corporation or a great source of opportunity for the company… depending on how management plays along with their ideas.
Here in 2019, there hasn’t been a bigger headline-grabbing activist investor than Elliott Management. Back in January, the group put out a plan to change the direction of legacy tech giant eBay. It called for cutting costs, divesting operations and streamlining its core business — nothing surprising for an activist to want.
eBay had the choice: ignore its activist shareholder and continue on with its multiple side businesses… or work with the investor and enact some of its plan. It took the latter course and was rewarded:
Clearly, the rest of the market thought highly of the plan and eBay’s cooperation with it, sending shares skyrocketing to start the year and jumping as much as 48% at one point this summer.
Of course, an activist like Elliott wasn’t done with its market meddling.
Early last month, the group announced it had acquired a $3.2 billion stake in AT&T Inc. (NYSE:T) and had a plan to grow that company’s share price by as much as 65% over the next 24 months.
AT&T investors have been waiting patiently these past six weeks to see what the company would do about this plan. This week, they got their answer.
Elliott wanted basically three things out of AT&T: debt reduction (from its massive Time Warner merger), higher dividends and buybacks… and a strategy to unlock some of AT&T’s deeply undervalued assets (like HBO, again from the Time Warner deal).
In AT&T’s Monday morning earnings release, it gave in. The telecom giant proposed a three-year capital allocation plan, which includes debt reduction (check), dividend growth and buybacks (check) and a relaunch of streaming HBO service called HBO Max to compete with Netflix, Hulu, Apple and Disney (check).
AT&T’s CEO and Chairman Randall Stephenson said, “I’ve found our engagement with Elliott to be constructive and helpful, and I look forward to continuing those conversations.” I bet he does. If Elliott can do for AT&T what it did for eBay, he will be sent off in his planned end-of-2020 retirement even wealthier.
Of course, if it were all this simple, companies would court Elliott Management as a turnaround consultant expert. But they don’t. Elliott doesn’t always get its way… and if when doesn’t, things can get ugly.
In an amazingly-detailed takedown of Elliot back at the end of 2017 by Fortune, Jen Wieczner outlines several of Elliott’s disasters, including an incredibly complicated situation with Samsung that even had political ties and was involved in the impeachment of South Korean President Park Geun-hye and the imprisonment of Samsung’s Jay Y. Lee.
Now, investors did make money on this one. But it was a painful investment watching events unfold and seeing Elliott’s ruthlessness. I urge you to go read that piece by Wieczner.
In short, Elliott doesn’t mess around… and it doesn’t always win.
So, while Wall Street is praising AT&T for following Elliott’s advice so far, this story has yet to be written in full. Of course, how does an honest trader play such a situation. We only know that this partnership will result in some massive price movement. But we don’t know if this is another Samsung or eBay.
Fortunately, we don’t have to. We can play price movement without betting on its direction using a favorite strategy of ours. Let’s get right into it…
A Strategy to Play Short Term Volatility
While most investments out there force you to either go long (buying stock or buying a call option) or go short (shorting a stock or buying a put option), there are always exceptions. A long straddle trade is just such an alternative.
Rather than going long or short a stock, a long straddle basically lets traders do both at the same time. The way it works is by buying both a call option and a put on the same stock, with the same strike price and expiration date.
This may sound counterproductive, but it really does make a great deal of sense. You see, both legs of this trade don’t have to go up for this to produce a profit. Only one – whether shares rise sending the call sky high or shares fall sending the put up – has to jump enough to produce an overall profit.
And the best part is that this kind of strategy offers nearly unlimited profit potential. Basically, the further the underlying shares move away from the strike price (in either direction), the higher this trade’s profits grow.
You can see how it works here:
Source: The Options Industry Council
Clearly, the risks are limited to just the amount it takes to open this trade. And if shares move in a large way – as AT&T’s should with its new partnership – the profit potential is virtually infinite.
Let’s look at a specific trade using a long straddle to see how this might play out…
A Specific Trade on AT&T
Following yesterday’s post-earnings jump, shares of AT&T are trading at $38. So, that’s where this trade begins.
A trader looking to use a long straddle on T could buy a December 20 $38 call for $1.06 per share and a December 20 $38 put for $0.91 per share for a total cost of $1.97 per share. Since each option represents 100 shares of T, that’s a net debit of $197 to open this trade.
That’s the total amount at risk here. But it is only at risk if AT&T’s shares don’t move a penny from now until nearly Christmas. That’s clearly unlikely.
And as noted above, the further those shares do move, the greater the profit potential. Of course, they do have to move a bit before that entry cost is recouped.
To find out exactly where those points are, it takes some simple math.
If shares of T continue to rally on news of its Elliott partnership, they’d have to go up past $39.97 ($38 strike + $1.97 entry cost) to make this trade profitable. Alternatively, if shares fall following this initial investor enthusiasm, anything below $36.03 ($38 strike – $1.97 cost) is pure profits.
In either case, that represents a move of just 5.2%. With so much at stake – this activist investor, an aggressive capital restructuring plan, the 5G rollout and the ongoing streaming war – that’s nothing. Shares could end this year far from today’s price – either up or down. In either case, this trade wins.