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Long dated options after acquisition/bankruptcy?



February 06, 2014 – Comments (8)

So I was having a Shower Thought™ today and it occurred to me that I don't know what happens to long dated stock options after M+A activity or a bankruptcy.

Example:  I buy a long dated call option on XYZ corp at a strike price of $10 and a settlement date of Jan 2020.  Then, in June 2014, ABC Megacorp acquires all of XYZ corp by means of a $15 tender offer.

$15 is pretty good and my thesis that XYZ shares are worth more than $10 has been validated.  But what happens to me?  There will not be any shares of XYZ to tender to me in Jan 2020.  Are optionsholders like me made whole by ABC as part of the tender?

Example 2:  I buy a long dated put option on QRS corp at a strike price of $10 and a settlement date of Aug 2019.  Then, in April 2014, QRS corp goes bankrupt - dead in the water, stock price $0.001 and then delisted.

What happens to me?  My thesis was right - QRS corp shares are worth considerably less than $10.  But there will be no shares for me to buy and tender in Aug 2019.  Who takes it on the chin? 

8 Comments – Post Your Own

#1) On February 06, 2014 at 1:34 PM, ikkyu2 (97.93) wrote:

By the way, I gotta apologize for an error in my last blog entry.  Both the stock screeners I looked at reported wrong market caps for Berkshire Hathaway.  Not sure why, but I think they were reporting capitalization for A shares and B shares separately.  Google Finance doesn't do that; it correctly reports the cap of BRK at around $280 billion, nearly double that of FB.

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#2) On February 06, 2014 at 1:58 PM, constructive (99.97) wrote:

Since there is minimal uncertainty about the final price, the time value of the option falls close to 0. The option trades close to exercise value.

American style options are exercisable at any time (and also buyable/sellable assuming a liquid market), so the underlying doesn't need to be trading on the strike date.

Example 1, your option will be worth close to $5 and you can exercise or sell it at that price. But that doesn't mean you will necessarily make money on this trade. With the time value disappearing, the underlying stock can go up quite a bit and you can still lose money.

Example 2, your option will be worth close to $10 and you can exercise it or sell it at that price.

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#3) On February 06, 2014 at 4:56 PM, somrh (86.25) wrote:

I guess to add to what Mega said, I'm assuming the question is how does OCC handle exercises. Yes?

Whenever there's a special situation, they release a report detailing what option holders will receive in the event of exercise. Cash settlement of the value is common but it may differ on a case-by-case basis.

To give an example of a goofy situation, I had call options on Sara Lee prior to the spinoff. The spinoff resulted in the owner of 100 shares of SLE receiving:

1) 20 shares of HSH (Hillshire Brands)
2) 100 share (?) of DE Master Blenders (listed in the Netherlands)
3) $300 cash ($3 special dividend per share)

Since DE was not listed in the US (well, you can buy it on OTC but that's not the same), they basically took the average of the first few trading days and cash settled that portion of the option. 

So what you actually get if exercised would be the 20 shares, and then a pile of cash ($300 + whatever the DE shares were worth at the time when they were granted).

Since it was a goofy situation (the option now corresponds to an odd lot + cash), the options were mispriced with huge bid/ask spreads. The bid ended up being lower than exercise value. (Yes, I tried to buy. No, the fish weren't bititng.)

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#4) On February 06, 2014 at 5:02 PM, somrh (86.25) wrote:

OCC? CBOE? One of those....

Here's the Sara Lee report they released

So if you're in that kind of situation, wait for a report to be released and see how they choose to handle it.

But for your scenarios, they would be probably just be cash settled for about the value you'd expect them to be worth.

. . . 

And one variation on your #2 scenario, I had options on some reverse mergers that expired during a trading halt. There, I had to decide if I wanted to exercise and ended up being naked short stock until trading resumed at which point I had to cover in 3 days.

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#5) On February 06, 2014 at 11:24 PM, ikkyu2 (97.93) wrote:

Thanks somrh.  You make it sound like it's different in each situation.  I appreciate the input.

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#6) On February 07, 2014 at 3:04 PM, Valyooo (38.19) wrote:

I would imagine it's usually cash settled

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#7) On February 08, 2014 at 3:33 PM, ikkyu2 (97.93) wrote:

When you assume, Valyu, you make an ass out of u and me!

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#8) On February 08, 2014 at 3:57 PM, somrh (86.25) wrote:

Yeah, it can be different between situations. But most similar situations are handled in the same way.

Here's their contract adjustment page.

A few examples:

Cash Buyout: As already pointed out, they usually get cash settled. And as Mega noted, the time value would be about $0 since they're American style options. A lot of times, they actually move the expiration up as in this example since there is no point in holding them after the deal closes anyway.

Cash + Stock Buyout: So here's a situation where the buyout was part cash and part stock. The option contract gets entitled  to the cash, plus the shares of the acquirer plus the cash value of any fractional shares. 

Special Dividend: they usually just adjust the strike price by the special dividend amount such as here.

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