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Q: What happens if I am short calls in the stock of a company which is subsequently taken over before the expiration date?
A: Corporate actions such as mergers, acquisitions and spin-offs will often necessitate a change to the amount or name of security that is deliverable under the terms of the contract. When such adjustments occur, the short call position is responsible for delivering the adjusted security.
For example: The shareholders of company JKL Inc. have approved a takeover bid placed by Global Giant Co. As a result, holders of JKL stock will now be entitled to a 1/2 share of Global Giant for every share of JKL Inc. they own. Therefore, holders of JKL call options will now be entitled to a deliverable amount of 50 shares of Global Giant for every contract of JKL that they are long (100 shares per contract x .5 Global Giant). Investors with short positions in JKL call options would then be responsible for delivering 50 shares of Global Giant for every call option assigned.
For the sake of this example, a simple conversion ratio was used, though not all corporate actions result in such clearly defined terms. Often assignment will require the short position to deliver fractional shares plus cash equivalent. An adjustment panel consisting of representatives of the listing options exchanges and OCC (who only votes in case of a tie) makes a determination whether to adjust an option as a result of a particular corporate action by applying general adjustment rules. Again, whatever the terms, the short position has the potential obligation of delivering the adjusted underlying.
Q: What happens with my options contracts when a company is delisted from an options exchange?
A: If a stock fails to maintain the minimum standards for price, trading volume and float prescribed by the options exchange, option trading can be wound down even before the stock is delisted by its primary market. In that case, no new series would be added at expiration. Trading in existing series would continue until they go "off the board". If trading in the underlying stock is suspended by its primary market for an extraordinary reason before the expiration of outstanding options, the options exchange will specify a procedure for the orderly liquidation of option open interest in a special bulletin.
Q: How can I tell if an option contract has been adjusted?
A:
There are several ways that an investor can confirm that an options contract has been adjusted and what the terms of the options contract are.
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Adjustment Memos
The International Securities Exchange (ISE) posts contract adjustment memos to its website that give detailed information as to how outstanding option contracts will be adjusted due to a corporate action.
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Equity Special Settlement Report
The Options Clearing Corporation provides a report that contains all options contracts with a non-standard deliverable.
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Series and Strikes
The OIC has a page on its web site titled Series and Strikes where by entering an options root symbol not only can an investor obtain all series and strikes available for an option but also obtain a description of the option. The description of the option will usually contain the adjustment type, such as spin-off, merger, and distribution.
Here are two hints that an option has been adjusted.
- The option appears to be "mispriced". Review the whole option string or chain of options to see if this is pricing appears for call and puts in all strikes. It is highly unlikely that mispriced options exist for a whole option class. There are no free lunches in the financial markets. If they exist, market forces ensure they do not exist for very long.
- Two option root symbols share the same strike price. In some cases, an adjusted non-standard contract will appear alongside a standard, 100-share contract. when looking at a string of option prices for a particular underlying look to see if all the symbols are identical. These contracts, while having the "same" strike price will have different option root symbols. In many cases, the price differences between these two contracts can vary significantly.
Q: XYZ Inc.'s stock was recently trading at .60 cents before undergoing a 1 for 10 reverse stock split and is now trading at $6.00. Is my call option with a strike of $5 that was outstanding at the time of the reverse split now in-the-money by $1.00?
A: No. The call option should not be in-the-money. All XYZ Inc.'s option contracts that were outstanding on the effective date of the 1 for 10 reverse split have would be adjusted to reflect the reverse split. An option contract for a reverse split is typically adjusted as follows:
Strike Price - No change
Number of Contracts - No Change
Multiplier - Strike Price and Premium Multiplier remains 100
New Deliverable per Contract - 10 shares of XYZ Inc.
The value of 10 NEW shares of XYZ Inc stock @$6.00 per share is $60.00 dollars. The value of the strike price (if exercised) is $500.00. To determine the point at which the post-split stock needs to be for the $5.00 call to be in the money, divide the value of the strike ($500.00) by the number of shares that Underlies the contract (10). This would indicate that the stock would need to be trading above $50 per share for this adjusted contract to be in the money.
You can view previous adjustment memos posted on our website.
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