Carl Icahn has jumped into the shark-infested waters of corporate activism once again. In an effort to help friends and shareholders of the Internet company Yahoo! (NASDAQ: YHOO, Stock Forum), he has put himself in the middle with a huge stake in the company. He has purchased about 50 million shares of the company for approximately $1.5 billion, and has plans to add to his holdings. This is in response to Yahoo's board rejecting a bid from Microsoft Corporation (NASDAQ: MSFT, Stock Forum) that would have added over 60% to the pre-announcement close.

I remember a time, not that long ago, when some friends of mine asked me to help them with an investment. They had put a lot of their portfolio into a small pharmaceutical company that had a promising drug trial going on. The drug came through the trials better than expected and their share value went up.

The jump in share price was not as much as they had hoped for, but there were rumors of a possible buyout, so they held on. They held on and a buyout offer did come and it was for a price higher than they thought the stock would get in the next three years. The board, however, declined the offer, saying the company was worth more. (Does this sound familiar?)

The acquiring company was not inclined to offer more for the deal and walked away from the table. The share price fell to just above pre-trial levels and my friends asked me what could be done. Since neither they nor I had the funds or friends to make many waves, all they could do was sell and get out with what they could.

They all made a little on the deal but nowhere near what they could have. It left us all wondering what shareholders could do if the board did not seem to be acting in their best interest.

We fast forward a few years and find some friends of Mr. Icahn in a similar situation, but with one major difference. Mr. Icahn, unlike me and my friends, can put enough money into motion to get his way, or at least be seriously considered. Riding a wave of shareholder anger over the way Yahoo's board handled the failed talks, Icahn bought a substantial stake in the company and announced his own slate of director nominees to challenge the incumbent board in the coming elections.

Subsequent to Icahn's announcement, however, it was revealed the two companies were talking about a partnership instead of a merger at this point. What that will mean for Icahn and other shareholders in the long run is not clear. If the partnership goes forward and the new board is voted in, Mr. Icahn and friends may find themselves in the position of actually managing the company and not just selling it. The board he has put together probably could do the job, but do they really want to?

No matter what happens with the board, the deal, or the company, you can still make some profits off the situation. The stock hit a 52-week low of $18.58 back on January 30, just before the MSFT announcement. Post-announcement, the stock went as high as $30.25 – some 62% above the January ending low. Since the deal was called off, the stock has fallen off slightly and now trades in the upper $20s.

Since the stock was headed toward the teens prior to the announcement by MSFT, it can be expected to return there if no union can be reached. The MSFT bid has opened the door for some other interesting combinations as well. Should any of those work out, and we can reasonably expect there will be at least one that does, share value should improve.

How can you play this today, without taking the risk of a big drop in the stock price? Using a hedged option strategy you can do an October call debit spread that is well in-the-money. This way, if the stock does fall, we will have some protection.

By doing a debit spread, your maximum loss is the amount paid to enter the trade. If you were to buy the stock, you could be on the hook for a dollar-for-dollar drop in share price. As long as the share price stays above your sold position, however, you won't be losing anything.

For a hedged trade on YHOO, you may want to consider the October 20/17.50 call debit spread for a 2.25 debit. That's an 11.1% return, and the stock has to fall 26.8% to cause a problem.

If you want immediate gratification, you may consider the October 20/17.50 put credit spread for a 25 cent credit. This is also an 11.1% return, and the stock has to fall 26.8% to cause a problem.

Either way, if the stock falls, you have 26% protection. If you own the stock and it falls 20%, you just lost 20% of your investment. With these trades, you will still have a winning trade.

Nothing is without risk, and you should be sure the risk of any trade fits with your personal investment goals and tolerances. Remember to keep things in perspective and have a little fun, too.

This week Investors Observer covers:

 Yahoo/Microsoft and Mr. Icahn… What can investors do to be on the winning side?

Articles:

* What Company Could Be The Next Possible Google? + Lee’s take on YHOO, BKS, KFT, IBM, BAC, AMR, and MMM

* Searching for Understanding of Yahoo!

* Riding Icahn's Coattails

* Who Gains from the Microsoft/Yahoo! Dance? Google.

 Click Here to read any of these articles.

 

Vic Wisemann
Lead Analyst

Vic Wisemann is an equity option strategy analysts with Investors Observer. Mr. Wiseman manages several portfolios for the company and comments weekly on his insights, strategies, and tactics for playing the market to win.

DISCLOSURE: Mr. Wisemann owns and/or controls diversified portfolios of long and short stock and option positions that may include holdings in companies he discusses in his articles.