Goldman Urges Clients To Use Options For M&A Bets

Goldman Sachs Group Inc. (GS) is telling clients to start placing bets now for a potentially big year for mergers and acquisitions.

Strategists at the firm said Wednesday that investors should use the options market to juice profits as expectations rise for more deals this year. Goldman believes the market has yet to aggressively target takeout candidates using options, leaving the prices of contracts in takeover candidates relatively cheap.

Goldman even pointed out companies whose options contracts could rise most if a deal is announced, including botox-maker Allergan Inc. (AGN) and satellite-television provider DirecTV Inc. (DTV). Goldman said in the report that these companies could be among the companies that help drive deals in 2011, when M&A is already up 6% from the same period last year, Dealogic data show.

"While investors seem more comfortable trading M&A views with options, pre-positioning remains modest, offering compelling opportunities," Goldman Sachs derivatives strategists Katherine Fogertey and John Marshall said in the report.

They said pricing trends in the options market point to opportunities for traders to make cheap bets on takeout candidates. Specifically, Goldman sees the relatively high volatility readings for longer-dated options contracts and relatively low volatility readings for shorter-term options.

Options-contract prices in Allergan, DirecTV, VMware Inc. (VMW), Textron Inc. (TXT) and Estee Lauder Cos. (EL) reflect the least amount of M&A potential among Goldman's list of potential takeover candidates. A spokesman for VMware said the company doesn't comment on market speculation. Allergan, DirecTV, Textron and Estee Lauder didn't immediately return calls seeking comment.

Longer-dated volatility measures have risen, with investor anxiety over the unrest in the Middle East and North Africa. Since the price of long-term options contracts tends to fall steeply in the wake of deal announcements, the strategists recommended investors sell long-term contracts.

At the same time, Goldman advised options traders to buy near-term calls that capture stock spikes that usually follow deal announcements. The strategy is designed to pay off if a deal materializes, but also benefit if the underlying stock rises in the absence of a deal. Calls convey the right to buy a company's stock and puts convey the right to sell a company's stock.

For DirecTV options, Goldman's strategists suggested buying June $48 calls and selling $40 puts and $60 calls that expire in January, a trade known as a "strangle." Shares of the satellite-TV provider fell $0.48, or 1%, to $46.29 in recent trading.

Goldman recommended a similar strategy for small-aircraft maker Textron. Goldman said options traders should buy June $28 calls and then sell January $25 puts and $35 calls. Shares rose $0.08, or 0.3%, to $27.38 recently.

For Allergan, Goldman advised owning April $75 calls and selling $65 puts and $90 calls that expire in December. Allergan shares fell $0.58, or 0.8% to $71.47 recently.

-By Chris Dieterich, Dow Jones Newswires; 212-416-2611; christopher.dieterich@dowjones.com

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