Sprint’s Saga

As a Sprint (S) customer, I have my own unenthusiastic customer service and technical concerns with the company , but that is not the subject at hand now. Sprint has obviously been having some problems with retention in general. Sprint has been rapidly losing customers for some time now and their balance sheet has reflected this.

I don’t think the launch of the Palm (PALM) Pre in June really helped the company. And since neither Palm nor Sprint will say how many of the devices have been sold, it is even more difficult to gauge the effect.

After a positive initial launch, analysts said recently that they think sales have slowed and dropped below the operator’s expectations. From personal experience as well as from reading hundreds of reviews online, it would seem that Pre technology falls short of expectations and the reception of the Pre has been lukewarm — nothing on the scale of what was expected and certainly minimal compared to the launch of the first iPhone from Apple (AAPL).

Sprint did launch a new $69.99 unlimited "mobile-to-mobile" wireless calling plan, which could shake things up a bit in the space. The "Any Mobile, Anytime" plan will include voice, data, text, e-mail, GPS navigation, and distribution of videos and images from one mobile phone to another. But "cheap" plans don’t always mean success.

AT&T (T) and Verizon (VZ) have a comfortable lead in that sector and seem to have better service coverage. Although anecdotally, I have found that most folks complain about their service at one time or another, no matter who the carrier is.

To top it all off, Deutsche Telekom approached adviser Deutsche Bank AG to examine a possible takeover of Sprint; this data was published in the London-based Telegraph last night. Sprint stock is currently 10% higher, trading up 42 cents to $4.19 on this news.

I must confess that I have not dug in too deeply on this news, but I thought it would be a great time to talk about how options traders may place a “takeover bet” on a stock like Sprint. It is also a good time to talk a bit about what happens in the options markets once a merger or takeover is announced.

Generally speaking, once a possible takeover is announced or there is a substantial rumor of one, you will begin to see this priced into the options market, usually in the form of a vertical skew increase. Vertical skew is the difference in implied volatility in different options in the same month. Skew can come in several different shapes. With a takeover candidate, you will see upside skew (out-of-the-money calls and in-the-money puts) increase for obvious reasons.

In many cases, before an actual deal as been struck, you can use the prices being bid for upside calls to get a gauge as to what price investors see the deal being struck. For example, if you look at November 6 calls in Sprint, they are currently bid at 10 cents. The 7 calls are bid at five cents, so this would tell me it’s unlikely a purchase price from Sprint would be far above the $7.00 mark, at least not before November expiration. Of course, this does not mean it can’t happen.

Also, don’t forget that Sprint is a cheap stock to begin with; a $7.00 purchase price would still be a 66% premium to the current market price, and probably more than Deutsche Telekom would want to pay .

So, what happens after a bid price is accepted? Once a company has agreed to be purchased and agreed to a price, you will typically see a drop in the amount of time value for the options of the company being acquired. This is typical if the offer is an unchallenged all-cash deal, meaning it’s highly likely that the deal will be done for that price without any other suitors bidding for the company.

If the buyout is a cash-and-stock or all-stock transaction, the acquiree’s volatility may begin to closely resemble the volatility of the acquirer, because of the exchange in stock. So not only will you see the aquiree’s stock price move in lock-step with the acquirer, but the options may also act accordingly.

Once the deal has been settled and the company being acquired ceases to exist, ALL options will move to their parity value and will be exercised into stock or must be closed prior to that date.

The bottom line is that if you are unsure of the specifics of a takeover/merger involving a company you own in your portfolio, be sure you do your homework or contact a professional that has details on the deal itself.