Yahoo option traders bet on Microsoft deal

CHICAGO (Reuters) - Option investors bet heavily on Monday that Yahoo Inc might strike a deal of some sort with Microsoft Corp, spurred on in part by pressure from activist shareholder Carl Icahn.

Microsoft has proposed an alternative deal for Yahoo, a complex transaction that would include just buying Yahoo's search business, rather than a full buyout, a person familiar with the discussions said on Monday.

As part of the deal, Microsoft would also buy a minority stake in what remains of the company after Yahoo sells its Asian assets, the source said.

Representatives of software giant Microsoft and Yahoo, the No. 2 U.S. search engine after Google Inc, declined to comment.

"The question now is what form this deal will take," said Joe Kinahan, chief derivatives strategist at online brokerage thinkorswim Inc in Chicago. "During Monday's (option) trading, the perception was that this deal would get done at $30 (per share) or better."

Microsoft said it proposed an alternative deal to Yahoo over the weekend, rather than a full acquisition of Yahoo as it had originally proposed.

Yahoo shares rose almost 2 cents to close at $27.68 on Nasdaq. In the U.S. options market, roughly 169,000 calls and 163,000 puts traded in Yahoo, below its average daily volume 430,000 contracts, according to option analytics firm Trade Alert.

But a large part of the put volume was mainly due to more than 57,000 lots traded in the July $27.50 puts, which might have been sold as part of a large spread or a closing trade, both of which are typically perceived as bullish transactions.

Speculators bought June and July calls allowing them to buy Yahoo shares from $27.50 to $32.50 on hopes of making a profit if the deal commences at those prices or better, Kinahan added.

"We were really active in buying July $30 and $32.50 calls. My customers believe that there will be some positive outcome in the Yahoo shareholders meeting due on July 3," said an options trader who declined to be identified. "Traders are also rolling over their June positions into July in anticipation of that meeting."

ICAHN FACTOR

The latest tactic in Microsoft's pursuit of Yahoo comes as the Internet media company faces a bruising proxy battle with financier Icahn, who wants to install his own slate of Yahoo directors.

Icahn filed a preliminary proxy on Monday to nominate 10 directors to Yahoo's board.

In the filing, Icahn disclosed he owns nearly 10 million Yahoo shares, as well as call options allowing him to acquire another 49 million shares in the company. Together, they would give him a 4.3 percent stake in Yahoo.

"Clearly there are investors out there who think Icahn's plan has teeth, or at least that Yahoo will get back to $31 if Microsoft comes back with that offer again," said Randy Frederick, director of derivatives at Charles Schwab & Co Inc.

Microsoft made a cash-and-stock offer of $31 per Yahoo share in late January. Earlier this month, Microsoft discussed raising that offer to $33, but walked away after Yahoo management held out for $37.

"The Icahn factor is very important," said Michael Schwartz, chief options strategist at Oppenheimer & Co. "Based upon his track record of enhancing stockholders' value, the June $30 calls look like a good speculative trade."

In order for the June $30 calls to be profitable, Yahoo shares would need to go above $30, plus the price of their premium.

"Option investors believe the deal will be worth more than $31," Schwartz added.

(Additional reporting by Anupreeta Das in San Francisco; editing by Richard Chang and Andre Grenon)