News of a rejected takeover bid for Avon Products Inc on Monday had options players speculating on a better offer down the road, but some were cautious that the stock's bounce will end if a buyer does not emerge soon.
Avon rejected a $10 billion offer from smaller beauty product company Coty Inc. Its shares jumped on the news, gaining more than 17 percent to $22.71. The privately held Coty said it offered Avon $22.25 per share in early March, but failed to entice Avon into talks.
Stocks can sometimes rally sharply after a company turns down a bid because it suggests they may be looking at better offers, and some options players had that in mind Monday.
"The debate among option traders is will Avon shares move to the downside because the bid fails or will they move higher because the ante is upped in terms of the bid price for Avon," said TD Ameritrade chief derivatives strategist J.J. Kinahan.
"Put and call buyers are coming in on both sides of the options market," he said.
Option players have been taking positions in upside Avon calls for several months, most likely on prospects of a deal.
Traders were positioned in April, July and January 2013 $20 calls for the past few months "seeing a deal as a potential outcome," said Joe Kunkle, a founder of options analytics firm OptionsHawk.com in Boston, who said there was a high probability and consensus that Avon would be acquired.
Option volume on Avon was explosive at nearly 31 times the average daily levels, with 25,000 puts and 36,000 calls traded by Monday afternoon, according to options analytics firm Trade Alert. Avon is typically a thinly traded option name, averaging only about 2,000 contracts per day.
Some traders favored upside calls with the buying of the April $23 and May $24 strikes on hopes for a higher bid, said Steve Claussen, chief investment strategist at online brokerage OptionsHouse. "The trading is volatile because there are those who are buying puts expecting this is far from a done deal."
"We are seeing lots of retail selling (of options), meaning some investors are "not really believing higher prices are around the corner for Avon," said Jon Najarian, a co-founder of brokerage firm TradeMonster.com.
But he noted that opinion is not shared by institutional investors, as they purchase May $24 strike calls in blocks from 48 to 75 cents per contract.
The strong appetite for Avon options was accompanied by a sharp rise in option implied volatility, as players appear to be anticipating additional news on the buyout front, said WhatsTrading.com options strategist Frederic Ruffy.
The 30-day implied volatility for Avon options jumped 46.9 percent to 37.3 percent late on Monday, data from Trade Alert showed. Implied volatility, a key component of an options price, measures near-term future price expectations for the stock.
"This makes sense because of the potential of sharp price movement due to the takeover bid," said Steve Place, a founder of options analytics firm investingwithoptions.com in Mobile, Alabama.
"However this rise does not further expectation for upside in the shares. The rise may be put buyers who are hedging against the possibility that the takeover bid is pulled," Place said. "It could also be the possibility of investors hedging or taking advantage of this price pop to offset risk."
The most active option on Avon was the April strike put which gives the right to sell shares at $22 apiece by April 20 expiration. On Monday afternoon, more than 10,000 contracts traded in the strike, with 43 percent of the activity on the ask price, indicating they were bought, Trade Alert figures showed.
"One thing both retail and institutional players agree on is that they want to own protection at the 22 strike in April," Najarian said. "The April $22 puts traded from 20 to 75 cents (apiece) as investors of all levels wanted to lock in Monday's outsized gains in the shares by owning the puts."
Reporting By Doris Frankel; Editing by Chizu Nomiyama