A:

Typically, the announcement of a buyout offer by another company is a good thing for shareholders in the company that is being purchased. This is because the offer is generally at a premium to the market value of the company prior to the announcement. However, for some call option holders, whether a buyout situation is favorable will depend on the strike price of the option they hold and the price being paid in the offer.

A call option gives the holder the right to purchase the underlying security at a set price at anytime before the expiration date, assuming it is an American option (most stock options are). Effectively, no one would exercise this option to purchase the shares at the set price if that set price was higher than the current market price. In the case of a buyout offer, where a set amount is offered per share, this effectively limits how high the shares will go, assuming that no other offers come in and the offer is likely to be accepted. So, if the offer price is below the strike price of the call option, the option can easily lose most of its value. On the other hand, options with a strike price below this offer price will see a jump in value.

For example, on December 4, 2006, Station Casinos received a buyout offer from its management for $82 per share. Looking at the change in the value of the options that day gives a clear indication that some call option holders made out well while others were hit hard. On that day, the Jan 09 options with a strike price of $70, which was well below the offer price of $82, rose from $11.40 to $17.30 - a 52% increase. On the other hand, Jan 09 options with a strike price of $90, which is above the $82 offer price, fell from $3.40 to $1 - a 71% loss.

Some call option holders enjoy a healthy profit as a result of a buyout if the offer price comes in above the strike price of their options. However, option holders will be hit hard if the strike price is above the offer price.

For related reading, see the Options Basics tutorial.

RELATED FAQS
  1. How are call options priced?

    Learn how aspects of an underlying security such as stock price and potential for fluctuations in that price, affect the ... Read Answer >>
  2. Can an option have a negative strike price?

    The simple answer is that, at least when it comes to exchange traded options, an option can't have a negative strike price ... Read Answer >>
  3. How do speculators profit from options?

    As a quick summary, options are financial derivatives that give their holders the right to buy or sell a specific asset by ... Read Answer >>
  4. When is a call option considered to be "in the money"?

    Learn about call options, their intrinsic values and why a call option is in the money when the underlying stock price is ... Read Answer >>
  5. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
Related Articles
  1. Trading

    Options Hazards That Can Bruise Your Portfolio

    Learn the top three risks and how they can affect you on either side of an options trade.
  2. Trading

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
  3. Trading

    What's the Strike Price?

    The strike price is the price at which a derivative can be exercised, and refers to the price of the derivative’s underlying asset. In a call option, the strike price is the price at which the ...
  4. Trading

    Options Pricing

    Options are valued in a variety of different ways. Learn about how options are priced with this tutorial.
  5. Trading

    A Newbie's Guide To Reading An Options Chain

    Learning to understand the language of options chains will help you become a more informed trader.
  6. Trading

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
RELATED TERMS
  1. Strike Price

    The price at which a specific derivative contract can be exercised. ...
  2. Stock Option

    A privilege, sold by one party to another, that gives the buyer ...
  3. Bear Call Spread

    A type of options strategy used when a decline in the price of ...
  4. Out Of The Money - OTM

    A call option with a strike price that is higher than the market ...
  5. At The Money

    A situation where an option's strike price is identical to the ...
  6. Option

    A financial derivative that represents a contract sold by one ...
Hot Definitions
  1. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
  2. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  3. Mezzanine Financing

    A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing ...
  4. Long Run

    A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all ...
  5. Quasi Contract

    A legal agreement created by the courts between two parties who did not have a previous obligation to each other. A normal ...
  6. Wage-Price Spiral

    A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. ...
Trading Center