A Good Opportunity to Play a Bidding War

A few weeks ago, I discussed the proposed takeover of gold producer Placer Dome Inc. (NYSE/PDG) by Barrick Gold Corp. (NYSE/ABX) in a hostile takeover attempt valued at $9.2 billion, or $20.50 per share. At that time, it was unclear whether a so- called “white knight” would emerge and buy Placer. So far, the knight has not emerged, but Placer made it known that Barrick’s offer was “inadequate” and “opportunistic.” Clearly, this deal is all about money — and Placer naturally wants more for its shares.

 Rumor is, Placer is trying to get Newmont Mining Corporation (NYSE/NEM) to enter and force a higher bidding war for Placer. Placer has jumped to the $22-range, as traders believe a bidding war may be on the horizon, albeit far from a sure bet.

 As a trader, this may be a good opportunity to play a potential bidding war. But as I said, there is no guarantee one will surface. The risk for traders is buying Placer, and then having no other suitors turn up.

 What I would do in this situation is buy call options on Placer. The leveraged trade would cost much less than buying the underlying stock, and it entails far less risk. Should Placer fail to attract more bidders and the stock languishes, you would just lose the premium paid to establish the call, which is manageable. The reward is, if Placer takes off, you would fully benefit from a leveraged trade.

 Let’s take a look: Assume you believe a counter bid could emerge by March 2006. Given this, you could buy one contract of the in- the-money January $20 call for $265 per contract, excluding commissions. (Please note that this is not an actual recommendation — it is being used as an example of a call option). Now, assume a bid comes in for Placer at $24. Given this, you would make $135 ($24-$20 x 100 shares, less $265 premium) on the contract for a leveraged gain of 51% on the investment. Not bad.

 Now, if you instead bought 100 shares of Placer at the prevailing $21.95, the gain should the stock rise to $24 would be $205 (excluding commissions). Sounds better, but the $205 gain represents a percentage return of only 9.33%, versus 51% for the option trade. Not only that, but the option trader has a maximum risk of $265, while buying the actual stock entails far greater downside risk.

 When you are bullish but want to minimize the risk, call options make sense and are very easy to trade, as this example shows.