Oil prices surged and S&P 500 futures plunged after the news got out that Israel had attacked Iran, killing the head of the Islamic Revolutionary Guard Corps, guaranteeing a response from the Iranian government.

As global tensions escalate, the markets are expected to decline in the days ahead. Today’s options trading should be intense. 

In yesterday’s options trading, Papa John’s International (PZZA) had options volume of 24,548, over eight times the 30-day average. It also had two unusually active call options in the top 15 (6th and 14th spots), both with Vol/OI ratios of 43.23 and 37.05, respectively. 

On Wednesday, its share price jumped over 7% on news that Apollo Global Management (APO) and Irth Capital Management have made a $2 billion offer to take it private. Sources suggest the offer is in the low $60s a share. 

Assuming $61 a share is the price for Papa John’s stock that Apollo et al are willing to pay, going long on the pizza chain’s two call options would seem to be a no-brainer.

However, it might not be a terrible idea to consider selling the calls short, rather than going long. Here’s why.

Have an excellent weekend.

The 2 Options to Consider

As you can see from above, the two calls expire a week today, on June 20, with strike prices of $55 and $57.50, both below the supposed offer price.

In the case of the $57.50 strike, it had a volume of 10,073 yesterday, with one trade at 3:56 EST, accounting for all but 73 of the contracts. The buyer managed to secure the calls at $0.15 per contract, resulting in a total outlay of $150,000, or 0.26% of the $57.5 million required to purchase all one million shares.

The $55 strike had a volume of 10,559 yesterday, with one trade at 3:56 EST, accounting for all but 559 of the contracts. The buyer managed to secure the calls at $0.40 per contract, resulting in a total outlay of $400,000, or 0.73% of the $55 million required to purchase all one million shares.

Either way, it’s not a significant risk of capital for a large institutional investor. Hence the no-brainer tag. 

The Better Strike to Go Long

The institutional buyer needs the take-private deal to be announced before next Friday to make a significant profit on the bet. However, despite the markets likely heading lower on Friday, there’s no chance that the ask price will remain below $1.

As I am writing this, it is about 30 minutes until the markets open. Pre-market, its shares are off 53 cents, or 1.05%. By the time I’m finished writing my commentary, we should have prices for both calls. 

The profit probability as of yesterday’s close was 7.04% for the $57.50 call and 14.56% for the $55 call. Those aren’t the best odds. To break even, the share price must appreciate by 13.9% for the former and 9.4% for the latter. 

With few regulatory concerns that I can think of regarding Apollo and Irth buying a pizza chain, should the announcement occur, I don’t see a potential arbitrage play on this one, which means the price should jump to $60 or $61 on the news. 

At $61, the profit on the $55 strike would be $5.60, or an annualized return of 506.4% [$61 offer - $55 strike - $0.40 price paid per call / yesterday’s closing price $50.63 * 365 / 8].

At $61, the profit on the $57.50 strike would be $3.35, or an annualized return of 301.1% [$61 offer - $57.50 strike - $0.15 price paid per call / yesterday’s closing price $50.63 * 365 / 8].

Both are excellent returns. Unfortunately, as I said, the ask prices will likely be higher today. 

Another consideration is selling the calls before next Friday. 

The delta on the $55 strike was 0.1717, which means you would double your money by selling before expiration if it appreciates by $ 0.09 (0.2%). 

The delta on the $57.50 strike was 0.0781, which means you would double your money by selling before expiration if it appreciates by $1.92 (3.8%).

So, assuming the buyer didn’t know a deal was in the works, the $57.50 strike would make more sense because you’ve got a better shot at making money without exercising your right to buy 100 shares. 

The Argument for Selling Naked or Covered Calls

Typically, selling naked calls is a risky move because if the share price is higher than the strike price at expiration, the seller is forced to buy shares at the market price and then sell them to the call buyer at a lower strike price for a loss. 

However, if the seller is confident that the share price will remain below the strike price through expiration, they retain the income. 

In the case of the $57.50 strike, the annualized return would be 4.1% [Bid price $0.05 / $57.50 * 365 / 8]. The annualized return for the $55 strike would be 25.1% [Bid price $0.30 / $55 * 365 / 8].  

The $55 call scenario, given the news of a $ 61-per-share offer, brings a covered call into play. 

Let’s say you bought 100 shares at the close for $5,063. Then you sold one $55 call for $30 in premium income. Assuming the offer is legit, but gets postponed until after the June 2o expiration, you get to have your cake and eat it too, with the share price unlikely to breach $55 in the next eight days. 

However, the downside to such a move is that the share price moves above $55 at expiration. You’ll be forced to sell your 100 shares before getting the $61 offer, reducing your profit on the bet. 

The Bottom Line

As I conclude, one hour into Friday’s trading, the $57.50 call’s three latest trades all took place at $0.25, 10 cents higher than yesterday, while the $55 call’s latest trades have been between $0.48 and $0.50, also a dime higher than yesterday. 

Still reasonably priced, I would stick with going long the $57.50 call. In the worst-case scenario, the deal doesn’t materialize within the next week, and you’re out $25 per contract. The risk/reward proposition is tilted in your favor.

On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.