Chasing Value: E-Trade, a word of caution

The biggest obstacle to a deal is the latent home mortgage mess casting a giant shadow. This would require some serious due diligence, or as has been speculated a separation of the brokerage and banking interests. This is amusingly and sadly ironic because that used to be the law.

The loan loss problem has introduced the possibility that a larger bank like Bank of America (BAC) or Wells Fargo (WFC) might consider an acquisition. Both of them could more easily absorb the pain to the advantage of their second tier trading platforms that have more to gain.

At issue for me this morning is whether or not the current share price of E-TRADE is fairly valued. I own shares and options and have to decide if I want to take a bigger position or lighten up. The stock opened this morning at $1.63 and has been trading around there for a few weeks now. In many cases companies might occasionally be mentioned as potential merger or acquisition targets, but in the case of E-TRADE it appears to be a forgone conclusion.

Since this has been discussed for such a long time, I am lead to believe this inevitability is probably priced into the stock. Remember, over short periods of time fair value is hard to make certain, but the longer the time frame the more rational the price. For this reason I caution small investors not to make assumptions about a possible acquisition price at a significant premium. It could just as easily be that a buy-out offers only a nominal premium and the assumption of debt. And a premium over what price?

For this reason I think buying options might be a better strategy than buying the stock. In my case I am interested mostly in April puts with a $1.50 strike price paying about 25 cents if I "sell to open". This allows me to own the stock at $1.25 a share (much cheaper than today), which is my break even price should it be put to me, or make a 17% premium if the option expires, (a 50% internal rate of return). Today, the third Friday of the month is an option expiration date. There will probably be even higher premiums paid next week when July options become available.

In any event think twice about pouring your money into E-TRADE counting on a huge gain when and if it is acquired because any deal would fall into the category of worst kept secrets.

Sheldon Liber is the CEO of a small private investment company and the principal for design and research at an architecture & planning firm. He writes the columns Chasing Value and Serious Money. Disclosure: I own ETFC and WFC.