DOW’s potential income trading opportunity

There is an interesting income trade opportunity amidst buyout news of Dow chemical (Dow).

• Sell: Dow 50 calls, 40 Puts, May
• Buy: Dow 55 calls, 35 puts, September
• Credit received:  $0.15 per trade
• ROM: Difficult to estimate, at current IVs, it is $76 (15.6%) to $117 (24%) (per trade) by May expiration for $485 investment without considering upsides from adjustments.

This is an interesting play as it takes advantage of heightened volatility on 50 calls (only). As per current combined IVs, the breakeven points are $39 and $51.7 (at May expiration). IV has risen and is around 30%, this trade can tolerate another 10% drop in IV should the news of takeover subsides. If however, IV goes higher, this is even better for this trade as this DD is vega play.

The apparent risk with this though is, what if it is bought for $50biliions as rumored (i.e. $52 to $58 per share)? Two sides of the story: The company has announced that it is in no takeover discussions and is not open for sale.(Note, The company has been in takeover rumors since Mid Feb for one or other name). However, there is huge open interest at $50 across all the months. This income trade may absorb shock upto $51.7 but nothing beyond. Other then VMC, I haven’t played stocks for DD, so I will dig deeper but thought to share this interesting opportunity for reader’s benefit. Check out Forbes for details: http://www.forbes.com/2007/04/10/dow-chemical-update2-markets-equity-cx_af_er_0410markets30.html?partner=yahootix Company will announce results on April 26^th before market though, and till then I guess IV will either rise or remain where it is now.  So here we are, to take or not to take this opportunity.