Wedding bells in chemical sector this spring?

Someone hears springtime wedding bells in the chemicals space.

It’s been more than a year since Dow Chemical (NYSE: DOW) proposed a $130 billion merger with rival DuPont (NYSE: DD). Recent headlines have suggested regulators will bless the combination, and yesterday a large options trade positioned for final approval to be granted.

The strategy unfolded over a 25-minute period in the morning, with 16,600 May 65 DOW calls purchased for an average cost of $1.43 and a matching number of May 65 puts sold for $2.53. It was one of the largest transactions in a single-name equity and pushed total option volume in DOW to over 10 times the monthly average.

Calls are options to buy a security, offering the potential for gains if a rally occurs. Puts are usually bearish because they let investors unload shares, but they mean the opposite when sold. This time, the trader is on the hook to buy DOW for $65 if it’s below that level on expiration. 

The transaction essentially mimics owning 1.66 million shares. Because it generated a net credit of $1.10, their effective cost is $63.90, about $0.30 below the stock’s price at the time. They now stand to earn significant profits from DOW rallying. On the flipside, sharp losses will result from a move to the downside.

DOW 3-month chart

Source: OptionsHouse by E*TRADE

Both companies made new 52-week highs in February after Reuters reported that European antitrust officials would approve their combination.1 Further headlines in the last week suggested that other regulators were approaching similar decisions.2 The deal will be followed by a separation into three new companies, ultimately uniting the firms’ agricultural, chemical and specialty-product lines under the same rooves.

DOW rose 0.73 percent to $64.50 yesterday, and has made consistently higher lows while remaining trapped below its current level. Chart watchers often describe that pattern as an ascending triangle, with the potential for further gains if the higher price is broken. Aside from merger hopes, quarterly results are due from each company in in late April.

In summary, DOW has rallied on optimism about its merger, and one big investor is upping the ante on their bet that the deal will go through.

1. Reuters: EU regulators set to clear Dow, DuPont deal: sources. 2/22/17.

2. Dow and DuPont Inch Closer to Merger Approval 3/13/17, Fort Madison Daily Democrat: DuPont to merge with Dow. 3/20/17