Options trading : What does a buyout do to out of the money calls?

Question

I bought Jan 08 strike price 40 calls of a stock currently trading at 28$. What happens if in the next two months there is a buyout of the company for 36$ cash. Are my options worthless? What f the buyout is for 36$ of the other company's stock? Do I get new options in the buyer based on some complicated formula or do my options go worthless?

Answer 1

To treat everyone as fairly as possible when a buyout occurs, the existing options are adjusted to require delivery (if execution/assignmnet occurs) of the same thing the owner of 100 shares of the stock received in the buyout. The expiraton date for the option does not change.

For examples, see

http://www.cboe.com/tradtool/contracts.aspx

In your example, if the buyout was for $36 per share the owner of 100 shares would receive $3,600 and your option would give you the right to pay $4,000 to receive $3,600, effectively making the option worthless.

Similarly, if the buyout was in stock, say 2 shares of the buying company for each share of the company being bought, the owner of 100 shares would receive 200 shares of the new company so your option would give you the right to buy 200 shares of the new company for $4,000.

Answer 2

In the case of a straight exchange for stock, then a complicated formula occurs and the option continues if the other company is listed on the options exchange. In the case of cash, the option becomes worthless. You could of course, hypothetically, call the stock at 40 and sell at 36, but that would be nuts. If the buying company is a private firm or not listed, the options likely just cancel.

In the case of a cash and stock mix, I think the strike price is reduced by the equivalent amount of cash as a proportion of book value.

Also, in some circumstances, existing contract holders can be required to pony up cash, or take cash to convert contracts back to units of 100 shares.

Generally, option contracts cease trading at the moment of merger announcement and the trading ceases permanently. However, you can still exercise the contract.

You should assume that the contracts will be worthless at the moment of announcement. Since you are so far out of the money, it is reasonable to believe you will never receive anything. If a merger is reasonable at this point, I suspect you will see option prices reflecting this since they are quickly on their way to worthless if approved. A worst case scenario would be a board accepting a cash payment for shares. These contracts would strictly worthless, you could never sell them, and although you could exercise them, it would cost you 400 plus commissions to do it and you would get nothing back.