What happens to my call options if the underlying company is bought out?

By Chad Langager AAA
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. A cash buyout agreement has been announced for a stock I own, but why isn't my stock ...

    The announcement of an acquisition or a merger does not necessarily mean that the deal will be resolved as originally stated. ...
  2. What was the most notable hostile takeover of all time?

    The drama of the RJR Nabisco takeover and wide coverage make it one of the most notable takeovers in history.
  3. What are the best indicators for evaluating technology stocks?

    Technology stocks are often some of the most discussed stocks on the news. How can investors spot the company that will roll ...
  4. What technical indicators can I use to find undervalued stock?

    Investors seeking new ideas may want to look to technical analysis to see whether the market has undervalued a particular ...
RELATED TERMS
  1. Forex Spread Betting

    A category of spread betting that involves taking a bet on the ...
  2. Roll-Up Merger

    A rollup (also known as a "roll up" or a "roll-up") ...
  3. Multibank Holding Company

    A company that owns or controls two or more banks. Mutlibank ...
  4. Short Put

    A type of strategy regarding a put option, which is a contract ...
  5. Money Flow Index - MFI

    A momentum indicator that uses a stock’s price and volume to ...
  6. Mass Index

    A form of technical analysis that looks at the range between ...
comments powered by Disqus
Related Articles
  1. How The Retail Investor Profits From ...
    Trading Strategies

    How The Retail Investor Profits From ...

  2. The Basics of Options Profitability
    Options & Futures

    The Basics of Options Profitability

  3. Gauging The Strength Of A Market Move
    Active Trading

    Gauging The Strength Of A Market Move

  4. Momentum Trading With Discipline
    Trading Strategies

    Momentum Trading With Discipline

  5. Confirming Price Movements With Volume ...
    Active Trading Fundamentals

    Confirming Price Movements With Volume ...

Trading Center