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Goldman can help you make money by anticipating M&A deals

<a href="">Ciara Linnane</a>

Investors can use movements in options to gauge expectations for M&A — and profit from them

Getty ImagesGoldman expects corporate purse strings to loosen this year.DMAMBMCMDMEMGZBZDZQZRZSZTZU

The mergers-and-acquisitions market is likely to heat up in 2018 as companies look to use tax savings or cash repatriated from overseas to fund deals, but many sectors and stocks have still not priced in the potential premium, Goldman Sachs said Friday.

Movements in listed options on stocks can be used to determine when institutional investors are expecting M&A activity, giving potential buyers of stocks a helpful guide, the bank said in a new report. And with activity expected to pick up after a slow 2017 when U.S. deals valued at more than $10 billion fell 18%, investors can use such option movements to their advantage.

“We believe knowing how much of a stock’s performance can be attributed to fundamentals, and how much is driven by investors positioning for more M&A will be key this year to offensively managing the size of long positions, as well as defensively avoiding potential pitfalls with shorts or underweights,” said the report, written by a team of analysts led by Katherine Fogertey.

For now, only 28% of the stocks that Goldman analysts view as having a 15% or higher potential for M&A are showing options movements that signal that expectation is baked in, said the report.

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The highest expectations are for the industrials and health-care sectors. The options market is currently pricing in some degree of M&A potential for 50% of stocks in the industrial sector and 39% of stocks in health care that Goldman analysts view as having a 15% or higher potential for M&A in the next year, said the report.

Health-care companies, along with tech companies, have traditionally held a lot of cash overseas, led by Johnson & Johnson(JNJ)and Amgen Inc.(AMGN) . The sector has recently seen some megadeals, including Cigna Corp.’s(CI)$67 billion acquisition of middleman pharmacy-benefit manager Express Scripts Holding Co.(ESRX)and CVS Health Corp.’s(CVS)roughly $69 billion bid for health insurer Aetna Inc.(AET) .

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But options investors are not pricing in the probability that shares reach the value that Goldman’s M&A analysts are forecasting if deals should materialize. “[W]e view health-care M&A as far from priced in and see the greatest opportunity for investors to leverage option markets to express views around M&A in this sector,” said the report.

Goldman listed these stocks as pricing in some M&A premium and said they’re likely to trade up sharply in the next three months:

NameTickerSectorIncyte Corp.INCYHealth careBristol-Myers Squibb Co.BMYHealth careXPO LogisticsXPOIndustrialsTwitter Inc.TWTRInformation technologyEdwards Lifesciences Corp.EWHealth careE Trade Financial Corp.ETFCFinancialsTime Warner Inc.TWXConsumer discretionaryYelp Inc.YELPInformation technologyMaxim Integrated ProductsMXIMInformation technologyNewfield Exploration Co.NFXEnergyCNX Resources Corp.CNXEnergyAdvance Auto Parts Inc.AAPConsumer discretionaryKimberly-Clark Corp.KMBConsumer staplesC.H. Robinson Worldwide Inc.CHRWIndustrialsTransDigm GroupTDGIndustrials

The bank listed these 10 stocks as having at least 15% potential for M&A, with investors not having yet priced that expectation in:

NameTickerSectorOccidental Petroleum Corp.OXYEnergyTextron Inc.TXTIndustrialsWhiting Petroleum Corp.WLLEnergyHumana Inc.HUMHealth CareWilliams Cos.WMBEnergyColgate-Palmolive Co.CLConsumer staplesXilinx Corp.XLNXInformation technologyMondelez International Inc.MDLZConsumer stapleseBay Inc.EBAYInformation technologyCiena Corp.CIENInformation technology

The Dow Jones Industrial Average (^DJI) has gained 1% in 2018 so far, while the S&P (^GSPC) has added 3%.

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Ciara Linnane is MarketWatch's investing- and corporate-news editor. She is based in New York.

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