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Trading Monster Beverage’s Boom And Bust, All In A Day

Published on May 2, 2012

Trading Monster Beverage’s Boom And Bust, All In A Day

May 2, 2012

Monster Beverage Corp (MNST) recently traded in a very volatile manner. Just before lunch on April 30th, MNST spiked sharply due to an M&A rumour that The Coca-Cola Company (KO) was in talks to buy Monster. As a result MNST spiked almost +30% to $83.96 from ~ $64

Later, for several hours it then traded around $75 level before giving back all the gains when Coca-Cola denied discussions to acquire Monster Beverage. During last 10mins of trading, MNST shares dropped to close at $65. This kind of volatile, uncertain situation can be rewarding for traders who are day trading options and are equipped with proper strategies to trade such opportunities.

There are three ways to trade options on M&A plays

  1. Pre- announcement (rumors)
  2. During announcement (when a news surfaces in mainstream media but is not yet confirmed) and
  3. When news is confirmed but M&A is not yet approved.

In this article, I shall show you how one could have profited from in situations like the one Monster’s stock experienced.

First, let me explain the concept. As soon as there is an unconfirmed M&A News, stock will usually jump and almost instantaneously underlying implied volatility will also jump. Once either the news is denied or confirmed, price as well as Implied Volatility will stabilize.

On April 30, as soon as possible KO and MNST M&A news surfaced, MNST Implied volatility rose for both Front and Back months. As per the chart below, May’12 options IV rose by almost 40%, from 45% pre-news to 65% during “non-confirmation” period. June Implied Volatility went up from 35 to 50%.

(click to know what is implied volatility, and how implied volatility can help you in making money. You may also want to read another article on AAPL to understand how implied volatility can affect option prices, and thus opportunities)

MNST IV Profile Change (Charts- LiveVol.com)

Let’s assume, you were late to the party; you saw that MNST has already spiked and stabilized around $75 and IV spiked too. As a smart investor you checked if Coca-Cola has confirmed the news or not? If it is not confirmed, the risk is ON. Stock can move in either side. What can you do? How could one benefit from this situation with little risk?

Allow me to show you how.

When MNST stabilized at $75, one could have purchased May $75 straddle for roughly $8.30 to $8.50. Buying a Straddle is an option trading strategy in which a simultaneous purchase of equal number of call and put options of the same strike and expiration occurs. This strategy allows one to benefit regardless of the direction stock moves.

Sounds simple! That’s what get-rich-quick-types would like you to believe. The key is not just knowing how can you make money, but also how can you lose money.

Your risk in this straddle was twofold-

  1. Implied Volatility Crush and
  2. Time Decay

What if the stock does not move between your opening the position and May expiration? What if the acquisition price is same as your strike price? What if the implied volatility drops significantly? All of these or any combination of these will result in losses and that’s what the key risk with this position was.

Now let’s assume you stress tested the position and decided to take risk. Here is how your straddle would have rewarded you by the end of the day. Your ~$8.50 straddle will be worth ~$11.2 resulting in +30% gains by the end of the day.

While this was the case of an elevated IV, straddles are often best used in the rising IV environment. There is much more to a straddle strategy than simply buying calls and put e.g. liquidity, implied volatilities, which strike, when etc. But this could be one of the powerful strategies in your toolbox to use when right opportunity strikes.

Know your craft and the success will be yours.

Disclosure: I am long MNST but I can change my positions anytime.

Disclaimer: Option trading can be risky, and you may lose your capital quickly if not done properly. Please do your due diligence before investing any money based on above. This article is for informational purposes only.

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