YHOO - Yahoo Inc.

[writser]

I'm no tax expert but I think you have to give the Yahoo / Ali Baba / Starboard team a bit of credit here. I'm sure the whole point of this deal is to avoid paying taxes and that they would never consider this crazy construction if they think they would have to pay taxes anyway when SpinCo is acquired.

 

On a tangent: Matt Levine is a great journalist - I really like his Bloomberg articles.

[innerscorecard]

Joe Tsai on Bloomberg basically said Alibaba had no interest in buying SpinCo or Yahoo. Not that it really means anything one way or the other.

[ni-co]

So, the spin-off will happen in Q4 2015 and, unfortunately, there are short restrictions on BABA. Yet, I figured with LEAPs I'm going to get an even better risk/reward ratio.

 

I bought some YHOO Jan 16 calls, strike $40, today for $7.72,

then I bought some BABA Jan 16 puts, strike $90 for $11.68.

 

This gives me a synthetic Jan 16 YHOO call with a strike price of 4 (= $40-0.4x90), for which I paid $12.39 (=$7.72 + $11.68 × 0.4). With the YHOO stock price at $43.60, this seems to be a pretty good deal.

 

My Black/Scholes calculator tells me that a Jan 16 call option with $4 strike and the stock trading at $43.60 should be worth ~$40… So, I got something worth $40 (in a EMH world) for $12.30. Have I overlooked something?

[krazeenyc]

So, the spin-off will happen in Q4 2015 and, unfortunately, there are short restrictions on BABA. Yet, I figured with LEAPs I'm going to get an even better risk/reward ratio.

 

I bought some YHOO Jan 16 calls, strike $40, today for $7.72,

then I bought some BABA Jan 16 puts, strike $90 for $11.68.

 

This gives me a synthetic Jan 16 YHOO call with a strike price of 4 (= $40-0.4x90), for which I paid $12.39 (=$7.72 + $11.68 × 0.4). With the YHOO stock price at $43.60, this seems to be a pretty good deal.

 

My Black/Scholes calculator tells me that a Jan 16 call option with $4 strike and the stock trading at $43.60 should be worth ~$40… So, I got something worth $40 (in a EMH world) for $12.30. Have I overlooked something?

 

I'm beyond confused. what are you trying to do here? Why do you buy the alibaba puts? you're already protected against a decline in yahoo past $40 (basically you're already protected against an alibaba decline already by buying yahoo calls). 

 

So you think Yahoo either goes up a ton or alibaba goes down a ton?

[ni-co]

So, the spin-off will happen in Q4 2015 and, unfortunately, there are short restrictions on BABA. Yet, I figured with LEAPs I'm going to get an even better risk/reward ratio.

 

I bought some YHOO Jan 16 calls, strike $40, today for $7.72,

then I bought some BABA Jan 16 puts, strike $90 for $11.68.

 

This gives me a synthetic Jan 16 YHOO call with a strike price of 4 (= $40-0.4x90), for which I paid $12.39 (=$7.72 + $11.68 × 0.4). With the YHOO stock price at $43.60, this seems to be a pretty good deal.

 

My Black/Scholes calculator tells me that a Jan 16 call option with $4 strike and the stock trading at $43.60 should be worth ~$40… So, I got something worth $40 (in a EMH world) for $12.30. Have I overlooked something?

 

I'm beyond confused. what are you trying to do here? Why do you buy the alibaba puts? you're already protected against a decline in yahoo past $40 (basically you're already protected against an alibaba decline already by buying yahoo calls).

 

I'm trying to create a call option on YHOO without BABA attached to it. I'm trying do this by buying the put instead of shorting BABA outright.

[krazeenyc]

So, the spin-off will happen in Q4 2015 and, unfortunately, there are short restrictions on BABA. Yet, I figured with LEAPs I'm going to get an even better risk/reward ratio.

 

I bought some YHOO Jan 16 calls, strike $40, today for $7.72,

then I bought some BABA Jan 16 puts, strike $90 for $11.68.

 

This gives me a synthetic Jan 16 YHOO call with a strike price of 4 (= $40-0.4x90), for which I paid $12.39 (=$7.72 + $11.68 × 0.4). With the YHOO stock price at $43.60, this seems to be a pretty good deal.

 

My Black/Scholes calculator tells me that a Jan 16 call option with $4 strike and the stock trading at $43.60 should be worth ~$40… So, I got something worth $40 (in a EMH world) for $12.30. Have I overlooked something?

 

I'm beyond confused. what are you trying to do here? Why do you buy the alibaba puts? you're already protected against a decline in yahoo past $40 (basically you're already protected against an alibaba decline already by buying yahoo calls).

 

I'm trying to short out the BABA price risk within the YHOO stock, only that I do it with a put instead of an outright short.

 

but you bought calls. You're already hedged!

[ni-co]

If I could do it with stocks I would buy 1 YHOO stock and short 0.4 BABA stocks. This way I'd create a YHOO post-spinoff stock, don't I? Now, when I go out and buy a YHOO call and 0.4 BABA puts I should be able to create a post-spinoff YHOO call or am I overlooking something here?

 

My thinking is: The put effectively guarantees me that I get my $90 per BABA share in January 2016 – that's $36 per YHOO share. So, buying the put lowers my strike YHOO call strike price by $36.

[krazeenyc]

So, the spin-off will happen in Q4 2015 and, unfortunately, there are short restrictions on BABA. Yet, I figured with LEAPs I'm going to get an even better risk/reward ratio.

 

I bought some YHOO Jan 16 calls, strike $40, today for $7.72,

then I bought some BABA Jan 16 puts, strike $90 for $11.68.

 

This gives me a synthetic Jan 16 YHOO call with a strike price of 4 (= $40-0.4x90), for which I paid $12.39 (=$7.72 + $11.68 × 0.4). With the YHOO stock price at $43.60, this seems to be a pretty good deal.

 

My Black/Scholes calculator tells me that a Jan 16 call option with $4 strike and the stock trading at $43.60 should be worth ~$40… So, I got something worth $40 (in a EMH world) for $12.30. Have I overlooked something?

 

I'm beyond confused. what are you trying to do here? Why do you buy the alibaba puts? you're already protected against a decline in yahoo past $40 (basically you're already protected against an alibaba decline already by buying yahoo calls).

 

I'm trying to create a call option on YHOO without BABA attached to it. I'm trying do this by buying the put instead of shorting BABA outright.

 

When you buy your call you're essentially paying a premium to protect all the way from $40 to $0 (Alibaba + stub) -- you're already protected against a big Alibaba decline.  Then you're protecting against an alibaba decline again by buying puts.  I don't think you've achieved what you wanted to.  If you want to own the Yahoo stub, you would just buy yahoo and buy BABA puts (or short BABA).  I'm not sure if there is a neat way to create calls in the stub. I'd like to own the stub myself if it were cheap enough.

 

I don't think your structure makes sense.

[thepupil]

Your structure does not make sense. Just buy Yahoo and short 0.4 BABA. It was restricted for short sale just for today because the stock was down a lot.

 

If you don't want to pay borrow because you think this will get too crowded, do so synthetically (sell call, buy put). You can short synthetically for no cost right now (you can sell the $90 call to buy the $90 put).

 

 

[krazeenyc]

Ni-co you essentially bought yahoo and 2x the puts.

[hillfronter83]

So, the spin-off will happen in Q4 2015 and, unfortunately, there are short restrictions on BABA. Yet, I figured with LEAPs I'm going to get an even better risk/reward ratio.

 

I bought some YHOO Jan 16 calls, strike $40, today for $7.72,

then I bought some BABA Jan 16 puts, strike $90 for $11.68.

 

This gives me a synthetic Jan 16 YHOO call with a strike price of 4 (= $40-0.4x90), for which I paid $12.39 (=$7.72 + $11.68 × 0.4). With the YHOO stock price at $43.60, this seems to be a pretty good deal.

 

My Black/Scholes calculator tells me that a Jan 16 call option with $4 strike and the stock trading at $43.60 should be worth ~$40… So, I got something worth $40 (in a EMH world) for $12.30. Have I overlooked something?

 

Only YHOO stub is trading at $43.6-$89.81*0.4=$7.6, not $43.60.

[ni-co]

So, the spin-off will happen in Q4 2015 and, unfortunately, there are short restrictions on BABA. Yet, I figured with LEAPs I'm going to get an even better risk/reward ratio.

 

I bought some YHOO Jan 16 calls, strike $40, today for $7.72,

then I bought some BABA Jan 16 puts, strike $90 for $11.68.

 

This gives me a synthetic Jan 16 YHOO call with a strike price of 4 (= $40-0.4x90), for which I paid $12.39 (=$7.72 + $11.68 × 0.4). With the YHOO stock price at $43.60, this seems to be a pretty good deal.

 

My Black/Scholes calculator tells me that a Jan 16 call option with $4 strike and the stock trading at $43.60 should be worth ~$40… So, I got something worth $40 (in a EMH world) for $12.30. Have I overlooked something?

 

I'm beyond confused. what are you trying to do here? Why do you buy the alibaba puts? you're already protected against a decline in yahoo past $40 (basically you're already protected against an alibaba decline already by buying yahoo calls).

 

I'm trying to create a call option on YHOO without BABA attached to it. I'm trying do this by buying the put instead of shorting BABA outright.

 

When you buy your call you're essentially paying a premium to protect all the way from $40 to $0 (Alibaba + stub) -- you're already protected against a big Alibaba decline.  Then you're protecting against an alibaba decline again by buying puts.  I don't think you've achieved what you wanted to.  If you want to own the Yahoo stub, you would just buy yahoo and buy BABA puts (or short BABA).  I'm not sure if there is a neat way to create calls in the stub. I'd like to own the stub myself if it were cheap enough.

 

I don't think your structure makes sense.

 

I see, thanks. I think I'm creating a post-spinoff YHOO call and go long BABA vol (a BABA long straddle), so it's not quite a stub call.

[thepupil]

My Black/Scholes calculator tells me that a Jan 16 call option with $4 strike and the stock trading at $43.60 should be worth ~$40… So, I got something worth $40 (in a EMH world) for $12.30. Have I overlooked something?

 

you are missing the strike adjustment that will occur when YHOO splits into SpinCo and RemainCo. There is no way you are outsmarting options traders to create something worth $40 for $12.30.

 

There is a way to profit from the stub being undervalued and that is to simply buy Yahoo and take some sort of bearish position in BABA (short, synthetic short, puts) to "lock in" BABA's current price. Of course there is a basis between SpinCo and BABA that you have to have an opinion on (should the discount be 0%, 10% or 20%?).

 

Your current "straddle" is odd to me and ensures you will pay out a lot of premium and needs pretty big moves in BABA to break even. If you want to be long vol in this funky way, that's fine. But you aren't buying $40 for $12.30.

[ni-co]

Your structure does not make sense. Just buy Yahoo and short 0.4 BABA. It was restricted for short sale just for today because the stock was down a lot.

 

If you don't want to pay borrow because you think this will get too crowded, do so synthetically (sell call, buy put). You can short synthetically for no cost right now (you can sell the $90 call to buy the $90 put).

 

Ni-co you essentially bought yahoo and 2x the puts.

 

Thanks, guys! That's exactly what I tried to achieve. I'm going to sell the BABA call, additionally, then I should end up with stub call, right?

 

[ni-co]

My Black/Scholes calculator tells me that a Jan 16 call option with $4 strike and the stock trading at $43.60 should be worth ~$40… So, I got something worth $40 (in a EMH world) for $12.30. Have I overlooked something?

 

you are missing the strike adjustment that will occur when YHOO splits into SpinCo and RemainCo. There is no way you are outsmarting options traders to create something worth $40 for $12.30.

 

There is a way to profit from the stub being undervalued and that is to simply buy Yahoo and take some sort of bearish position in BABA (short, synthetic short, puts) to "lock in" BABA's current price. Of course there is a basis between SpinCo and BABA that you have to have an opinion on (should the discount be 0%, 10% or 20%?).

 

Your current "straddle" is odd to me and ensures you will pay out a lot of premium and needs pretty big moves in BABA to break even. If you want to be long vol in this funky way, that's fine. But you aren't buying $40 for $12.30.

 

Yes, I got that. That's why I was looking for my mistake. Thank you, guys!

 

ps: I don't want to be long vol and certainly not in this way. I was only trying to reconstruct what I did here.

[thepupil]

So your position will be

 

Long 1      $40 Yahoo Call

 

Long  0.4  $90 AliBaba Put

Short 0.4  $90 AliBaba Put

 

This makes more sense, but I still do not agree with the approach. You should just buy the stock because paying call premium for your long leg is reducing a lot of your upside.

 

In my opinion the stub is worth $20 / share ($6 cash, $7 and change Yahoo Japan, $6 and change Yahoo Core). The stub trades for $7.80. ($43.73-0.4*89.81). So you've got a value gap of ($20-$7.80 = $12.20). The trade here is to isolate that stub. You don't need to hedge the value of the stub (buying the Yahoo call is in a way doing this).

 

By buying the Yahoo call, you are paying about $4 bucks of premium, which is about a 1/3 of the upside to convergence to NAV (too much!!!). You are overhedging and not creating a pure stub position. There's no reason to buy the Yahoo call. Just pay cash for YHOO shares. If cash is low, borrow from IB at 1.6% to fund the position.

 

My recommendation would be

 

Buy 1 YHOO Share

Synthetic Short on 0.4 BABA (locking in not having to pay borrow and a $90 / share BABA price, $36 to Yahoo)

 

When SpinCo comes out you will be

 

Long 1 RemainCo

Long 0.4 SpinCo

Synthetic Short 0.4 BABA

 

Let's say SpinCo trades at a 10% discount to BABA and BABA is where it is now. You'll then close out SpinCo and BABA positions and "lose" $3.60 which adds to the cost of stub, so net of that you'd create RemainCo for $11.40 per share, which is a great price and less than cash + Yahoo Japan.

 

 

 

[thepupil]

EDIT: Simplified this a little

 

The algebra looks like this.

 

Long Yahoo = 0.4SpinCo  + 1 RemainCoStub

 

SpinCo = BABA - SpinCo discount

 

Long Yahoo = 0.4(BABA - SpinCo Discount) + RemainCoStub

 

Let's add a short BABA to this equation

 

(43.73)-(0.4*89) = (0.4)(Baba - SpinCoDiscount)-0.4BABA + RemainCoStub

 

 

$7.81 = 0.4BABA - 0.4SpinCo Discount -0.4BABA + RemainCoStub

 

$7.81 = - 0.4SpinCo Discount + RemainCoStub

 

 

$7.81 + 0.4SpinCo Discount = RemainCoStub

 

The idea is that you are buying $20 of RemainCo intrinsic value for $7.80 + whatever SpinCo discount will be in $ terms.

 

I think I got that right, but feedback appreciated

 

 

[thepupil]

I ran this earlier today so the prices are stale. Before borrow costs, this is what returns look like of creating the stub. I'm assuming $20 / share intrinsic value of RemainCo. Returns are a function of whatever discount will be applied to RemainCo and SpinCo.

[ni-co]

Thanks, thepupil, you're right. Buying YHOO outright will nearly double my return (assuming the YHOO stub will trade at $20) by not taking on too much additional risk (risk of stub trading under $7,8 in 2016).

[ni-co]

I exchanged my calls for the stock. I might have to revert that someday, though. The problem with this approach is margin requirements. You have to lever one YHOO share effectively 5x to get the equivalent $ exposure per stub. The problem is that IB regards the short BABA and long YHOO positions as independent from each other with regard to margin requirements. From their point of view you're going completely crazy by doing this trade – even if you "only" put on a 20% position.

[ni-co]

Why isn't anybody interested in this stub deal? This seems to be a no-brainer to me. I shorted out BABA via Jan 16 puts/calls and essentially got paid for it! Seems odd to me that the arbitrage funds are not all over this.

[thepupil]

I assume they are all over this.

 

Ni-co, what do you think Yahoo core is worth and what do you think is the right SpinCo discount? The other components are easy

 

Cash $6

Turning to the balance sheet, at the end of Q4, end of the year, we had $10.2 billion in cash and markable securities. And as I stated previously,

cash taxes related to the Alibaba IPO proceeds are expected to be approximately $3.3 billion and will be paid in Q1. Adjusting for this tax payment,and convertible and other debt of $1.3 billion, our net cash balance to end the year was approximately $5.7 billion.

 

Japan $7+

Given its immense value, we made finding a solution for our Alibaba holdings a priority in the transaction announced today. While our holdings

in Yahoo Japan by comparison are a small fraction of our Alibaba holdings, we will continue to explore ways to maximize the value of Yahoo Japan,

continuing our commitment to be good stewards of capital.

 

But where are you on Yahoo? And where do you think SpinCo will come out?

 

One potential risk I see is a sharp rise in BABA, because this will increase the size of the SpinCo discount in absolute dollar terms and mean we pay more for the stub. To use an extreme. If BABA was $1000 and the 10% discount was $100 / share, you would lose a lot more on your short than you'd make on the long. I think the SpinCo-BABA basis may be some reason folks are scared.

 

On an even more paranoid note, I thought that Yahoo was a little aggressive in how they flaunt how they are doing this deal just for tax purposes. You could envision a Shire-Abbvie moment where political pressure is forced upon Sunnyvale and Barry O starts calling Yahoo unAmerican for this smart bit of estate planning. I know Malone does it all the time, but this is a unique structure (40 act fund) and you never know what some overzealous regulator can do.

 

Paranoia aside, I agree that this is a spectacularly interesting risk/reward. But I guess it's just the two of us for now.

[Guest Schwab711]

Why isn't anybody interested in this stub deal? This seems to be a no-brainer to me. I shorted out BABA via Jan 16 puts/calls and essentially got paid for it! Seems odd to me that the arbitrage funds are not all over this.

 

You should read up on Long Term Capital Management fund that went under in 1998. They had a lot of losses in paired arbitrage plays. One example was long/short pair on the different share classes of Shell. The share classes ended up diverging even farther apart and they didn't have the capital to continue the trade.

 

So my question is, are you in this stub because the perceived arbitrage or because you think the stub you created is going to increase earnings? If you are waiting for the market to fully value something you could be waiting for awhile (so your personal liquidity may matter if you are leveraged) and the amount of time you have to wait will ultimately determine your returns.

 

I personally don't like investing in situations where the time it takes the market to correct is the sole or dominant factor to my returns. I don't mind waiting for a price multiple correction if the underlying business is growing earnings itself. In those situations if the price stagnates then the P/E or whatever earnings multiple you prefer actually decreases which forces the market's hand even further. I think you are taking on a lot of different types of risk that have not been mentioned yet such as currency risk against the yen and yuan. Something to think about.

[thepupil]

Levering a share class arb spread of 1-3% 10:1 to make 30% IRR is a lot different than going long 10% Yahoo Short 8% BABA to create a 2 % stub or 20% and 16% to create a 4% stub. Also LTCM was into crazily lever fixed income like long the off the run tsy and short the on the run to pick up a few bps of liquidity spread and lever the shit out of it.

 

This is more Rockwood & Co at Graham-Newman* than Royal Dutch at LTCM.

 

*the Graham version of arbitrage, not the Buffett just buying the company with much reduced sharecount and making more $

 

EDIT: I know it's not a real and immediate arb like the cocoa beans trade, but my point is this "arb" is not a very highly levered  trade where you are taking advantage of a gross low single digit spread, you are buying Yahoo at 80% of NAV (25% upside to convergence, not 2% like in a share class arb) and hedging out a large component of NAV that happens to be in a $200B+ liquid large cap with diffuse ownership (no Volgwagen risk); you are taking on the SpinCo-BABA basis and this is not a true arb, there is risk, but it allows you to create the stub at the value of its liquid securities and 0 implied value for Yahoo Core

[thepupil]

 

 

I think you are taking on a lot of different types of risk that have not been mentioned yet such as currency risk against the yen and yuan. Something to think about.

 

what other risks do you see not mentioned?

 

The risks I can think of are

 

1) SpinCo BABA basis

2) valuation of Yahoo Japan (including currency as you mentioned)

3) valuation of Yahoo and its cash pile

 

To me the biggest risk is BABA going up a lot and SpinCo -BABA basis being higher than expected which means I won't be buying the stub with a fat margin of safety.

 

If SpinCo BABA basis is small, then I don't need to worry about the components of the stub, because I'm buying $20 for $7 (so there's lots of room for me to be wrong, Japan to go down in value, Yahoo to blow a shit ton of money on stuff etc.)

 

I'd like to here more risks though.