Best Way To Play Teavana

Teavana LogoTeavana (TEA) “operates as a specialty retailer of loose-leaf teas, tea wares, and other tea-related merchandise in the United States, Canada, and Mexico.” Earlier this month, Starbucks (SBUX) bought Teavana for $15.50 in cash and the deal was expected to close by the end of the year.

However, a week back, a short seller Glaucus Reasearch claimed that “independent laboratory tests show that Teavana’s teas contain pesticides in amounts that exceed U.S. and EU regulatory limits.” It advised that Starbucks walk away from the deal. Teavana shares immediately crashed below $15 and continue to trade between $14 and $15.

Glaucus Research does thorough work and focus on fraud at public companies. They have mostly focused on Chinese companies before Teavana. Their report is pretty through.

Now, I have no idea if the deal is going through. Obviously, the probability is still high that it will go through based on the Teavana stock price and option pricing. But there are some interesting ways to play this deal.

$15 May 2013 Calls

The simplest and best way to play this deal is to sell the $15 May 2013 calls. You can currently sell them at $.45 right now. For some reason they traded as high as $.50 yesterday and $.49 today. 

I am assuming that if the deal goes through, it closes at $15.50 and nobody comes in with a higher offer. If it does not, it goes below $15 and stays there. The stock was trading at around $10 before the deal and probably will drop below that if Starbucks reneges on the deal.

At the $.45 price, the probability the deal goes through is 90%. That is the highest out of all the options play. For example, the May 2013 $15 puts were trading around $1.50. If Teavana falls to say $7.50 if the deal falls through, it is pricing a 80% probability of the deal going through.

If you sell the 10 calls, your upside is $450 and downside is $50. A great risk/reward ratio.

Arbitrage Play

Since the probabilities are different for different option plays, there is more interesting ways to take advantages of this discrepancy. For example:

  • Sell 20 $15 May 2013 calls at $.45.
  • Sell 1 $15 May 2013 put at $1.50. 

You make money based on 2 simplistic scenarios.

 Scenario 1: Deal goes through at $15.50. You lose $100 on the calls, but make $150 on the puts for +$50.

Scenario 2: Deal does not go through and Teavana stock price goes to $7.50 and stays there till May. You lose $600 on the puts and make $900 on the calls for a profit of $300+. 

I have put in an order to sell May $.50 calls hoping somebody bites, but I may sell May  $.45 calls. 

Disclosure: I do not own any positions.