Unusual Options Activity in WBD Stock Hints the WBD-Paramount Deal Will Close Before August

As recently as mid-May, Paramount Skydance’s (PSKY) $110 billion acquisition of Warner Bros. Discovery (WBD) was on track to close on or before Sept. 30. However, in mid-May, Oliver Darcy’s Status newsletter reported that David Ellison was targeting July 15. 

On Wednesday, the markets were mixed, but WBD stock gained 1.2% on news that the European Union’s regulatory review of the deal would soon be complete and even better, the deal would get EU regulatory approval. 

In yesterday’s unusual options activity, someone clearly got the memo. Warner Bros. Discovery had the highest Vol/OI (volume-to-open-interest) ratio of options expiring in seven days or more and with at least 500 contracts traded. The July 24 $28 call had a volume of 18,807, 122.17 times the open interest.   

Given the previous reporting of the early closing date and WBD’s unusual call options activity yesterday, it’s clear that someone made a decent-sized bet that the sale would indeed close before July 24. 

Should you follow along?

The WBD Options in Question

Four things stand out for me. 

1) All four trades expire on the same day, July 24. 

2) All four took place at the same time yesterday at 10:37 a.m. ET. 

3) The two $30 call trades had a volume of 18,719, as did the two $28 call trades. 

4) The open interest on both the $28 and $30 calls had little to no open interest before yesterday’s trade. 

These four trades suggest someone was doing a large Bull Call Spread split into two parts. 

The Bull Call Spread 

As you can see from above, I’m using the July 24 $27 and $30 calls as an example of the bull call spread that a trader/investor made in yesterday’s trading. 

A bull call spread is a bullish bet where you believe WBD stock will increase in value by July 24. It involves buying a $27 call and selling a $30 call. The premium from selling the $30 call offsets the cost of buying the $27 call. 

The maximum you could lose on this bull call spread is the net debit of $2.18, which is the $2.25 trade price for the long $27 call, less the $0.07 premium for the short $30 call. Your maximum loss occurs if the share price at expiration is below $27. Your maximum profit would be $0.82 [$30 strike price - $27 strike price - $2.18 net debit]. You achieve maximum profit if the share price is above $30 at expiration. You make some, but not the maximum profit, between the $29.18 breakeven [$27 strike price + $2.18 net debit] and $30.  

Now, apply this to the four trades that happened yesterday at 10:37 a.m. ET. Don’t be put off by the different-sized trades. It is likely too big a trade to execute as a single clean trade in this situation. The important point is that 18,719 call contracts traded hands yesterday for both the July 24 $28 and $30 calls. 

1) The cost of the long $28 calls = $1,871,900  [$1 trade price * 18,719 long $28 calls * 100].

2) The premium of the short $30 calls = $327,500 [($0.18 trade price * 9,360 short $30 calls * 100) + ($0.17 trade price * 9,359 short $30 calls * 100)]. You’ll note that if you do the multiplication, it comes out to $327,583, rounded to the nearest penny, because of the different trades made to meet the 18,719 calls. 

3) The net debit is $1,544,000 or $0.825 [$1,544,000 / 18,719 contracts / 100 shares]. That is the most the trader could lose. The maximum loss would occur if the share price at expiration is below $28.

4) The maximum profit would be $2,199.482.50 [($30 strike price - $28 strike price - $0.825 net debit) * (18,719 contracts * 100 shares) ], or $1.175. 

5) The maximum profit return would be 142.5%. 

6) The risk/reward is 0.70 to 1. 

7) The profit probability of the $28 long call -- the likelihood that the share price is at the $28.825 breakeven -- as opposed to the $27 long call, would be higher than 28.7%, likely around 29%.

So, whoever made this bet believes there’s a 30% chance the deal will close before July 24.   

Should You Make This M&A Arbitrage Play?

The short answer is no. The longer answer is more nuanced than that. 

Assuming the EU approves the deal before Paramount Skydance CEO David Ellison’s July 15 target -- a report yesterday suggested that to meet EU regulatory approval, it will sell its 50% stake in United International Pictures to its joint-venture partner, Universal Pictures, by June 30 -- there remains the approval of the UK Competition and Markets Authority. That’s not expected until August. 

Further, a coalition of several states (New York, California, and others) are preparing a lawsuit to block the transaction because it reduces competition. This could delay the close until the fall and possibly beyond the Sept. 30 deadline. However, it would be possible for the deal to close after getting EU approval, while still litigating the transaction with the states. 

Beyond Sept. 30, Paramount Skydance has agreed to pay a “ticking fee” of 25 cents per share for each quarter after the deadline, in addition to the $110 billion. That amounts to approximately $627.5 million a quarter, according to Morningstar. So, there is a big financial incentive for PSKY to close by Sept. 30.  

The trader/investor who made this bet clearly believes the share price will rise over the next 30 days. If further news from the EU’s regulatory review emerges during this time, suggesting a timely approval in early August, the bull call spread will clearly possess more value. 

The big risk is that one of two things happens before July 24: Either the EU approves the deal unconditionally, or at least signals it will, and the share price pushes up to the $31 purchase price, where the short $30 call becomes a liability, or an unexpected higher bid emerges. 

A higher offer is unlikely. The bidder would have to pay a $2.9 billion termination fee to WBD, make an offer in excess of $31 a share, and still navigate a new regulatory approval process. That’s just too big a hill to climb. 

My guess is the trader/investor will close the position between $29 and $30. It won’t want to roll out the bull call spread beyond July 24 because it will effectively lower the potential profit due to the trade cost. 

While you could make this trade, I would say your capital is best saved for a more clearly defined risk/reward profile. You're best to leave M&A arbitrage to the professionals.