A Blackberry End Game!

Richard Croft
September 9, 2013
5 minutes read

There is little doubt that Blackberry (TMX: BB, Friday’s Close $11.29) is in palliative care. Management has set up a committee and hired two advisory firms to seek “strategic alternatives,” including the possible sale of the company. There is also a sense of urgency as all signs point to a November time line for an end game to this tragic story.

A specific time line with an uncertain outcome is fodder for option traders, a fact not lost in the market with Blackberry options trading at 60% plus implied volatilities. That implied volatility is in the top quartile of all Canadian options.

For some perspective, think about volatility in terms of an implied trading range for the underlying security. Consider, for example, the Blackberry December at-the-money options. At the time of writing the Blackberry December 11 calls were trading at $1.60 and the December 11 puts at $1.40. The combined cost of simultaneously buying the December 11 call and put at a total cost of $3.00 per share represents the range of possible outcomes.

The December straddle is a pure play on volatility because in that is no directional bias. The long call profits in a rising market while the put makes money when the underlying security declines. For the long straddle to generate an overall profit the underlying security must move up or down by an amount greater than the $3.00 per share cost.

Keeping with that theme the straddle’s $3.00 per share cost represents the option market’s best guess as to an implied trading range which, in this example, is between $8.00 ($11.00 strike less $3.00 premium = $14.00) and $14.00 ($11.00 strike plus $3.00 premium = $14.00) per share.

As for the range of possibilities – i.e. strategic alternatives – they include a cash infusion by a large institutional investor (OMERs and the Canada Pension Plan have been cited as possibilities) to shore up the company’s cash position, or more likely an outright sale of the company to a competitor who would attempt to transition Blackberry users to their own smartphone product line.

The latter strategic alternative will be a challenge as the number of potential suitors is dropping as fast as Blackberry’s market share. Microsoft was long considered a likely suitor for the acquisition / transition model, but with its recent US $7.7 billion purchase of Nokia, that possibility seems unlikely. Huawei, a large Chinese technology company, is an outside possibility and Hewlett Packard and Dell are longshots.

There is also a third equally plausible outcome in which Blackberry cannot find a strategic alternative. While management would put on a brave face, the market would see through it and pummel the stock price. In that scenario the floor would be zero.

What we have then is a November time line with three equally possible outcomes; two strategic alternatives that would favor the company (a cash infusion by an institutional investor or an outright purchase by a competitor) and one that would result in a sharp interim sell-off followed by a downward trajectory towards zero.

Unfortunately a failed attempt to implement one of the two strategic alternatives would be the best outcome for the straddle buyer. In that scenario volatility would increase or at a minimum stay the same and the sharp sell-off would cause the shares to trade below the downside target as defined by the implied trading range.

Should Blackberry orchestrate a strategic alternative, volatility would implode and the straddle’s value would decline. A cash infusion would prolong the inevitable beyond the December expiration, while a successful bid to buy the company would set an upside target that removes the uncertainty and, by extension, the volatility. Only if the purchase price was struck above $14.00 per share (considered very unlikely) would the straddle be profitable.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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