A Way to Play Yahoo on the Alibaba Bid

Yahoo! Inc.

Yahoo! Inc. (NASDAQ:YHOO) had a tremendous day on news of the Alibaba bid.  You are interested in picking up some shares to get some profit, but are afraid to pull the trigger.  If you are optimistic about the Yahoo’s future price, why not pick up some insurance on the stock while getting your profit up front?

Based on rates recently checked, buying 100 shares of Yahoo! Inc. (NASDAQ:YHOO) for $16.92/share and then selling the $17.00 April 2011 Call contract for $1.57 could net you 10.75% profit if YHOO closes above $17.00/share at the expiration date in 158 days.  Not bad for 5 months of investing and your average monthly gain would be 2.08%.  Additionally, you would have a big downside protection to $15.35, or about a 9.3% drop in stock price.

The Compound Annual Growth Rate (CAGR) on the assigned option position is 26.6%, which is better than the average overall long-term market return of 10%.

Possible Strategy if YHOO drops 9.3% and closes below $17.00:
If YHOO closes below $17.00 at any time during the trade& you can roll down the position by purchasing back the $17.00 April 2011 Call contract and then selling another call at a lower strike (say the $15.00 strike) and/or further date out to make up for any losses caused by having to buy the $17.00 April 2011 Call back.  If the stock recovers& you likely can simply sell out of the position for close to even money if you don't want it tied up in the positions.

If shares of Yahoo! Inc. (NASDAQ:YHOO) continue to drop, you now own the stock for less than $15.35/share when you were originally interested in buying at $16.92/share.  That seems like a pretty sound approach.


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