TK client alsol asked this question in a recent forum thread: “What happens if one has an option contract on a stock, and then this underlying stock is bought by another company? So is the case with Wyeth (WYE), which is on the process of being bought by Pfizer. Does the stock option contract remains intact, is liquidated, or is forfeited?”
Great question, alsol. Let’s start by settling a few points straightaway:
a) An option is never forfeited. The option owner’s rights remain intact, until the option expires.
b) Options positions aren’t liquidated either.
c) Your first choice, “the stock option remains intact”, is correct.
How does this play itself out? Let’s think through the situation. As a call owner you have the right to buy 100 shares by paying the strike price per share – and the put owner has the right to sell. Even post-merger, you still have the same rights.
Let’s say you owned a WYE Aug 45 call and the stock was bought out by Pfizer. Nothing really changes for you, except that if the stock gapped higher, you have a nice profit (or loss if the price gapped lower). You still have exactly the same rights you had before the merger: the right to pay $4,500 to receive whatever it is that the owner of 100 shares of WYE receives. The specifics of that deal are negotiated as part of the merger agreement.
A WYE shareholder may receive shares of the acquiring company, or they may receive cash or convertible preferred stock. It could even wind up being a combination of items. It doesn’t matter. The WYE shareholder will receive something for each 100 shares of WYE after the merger, and that same “something” is what the call owner has the right to buy (and the put owner has the right to sell) – each at the respective strike price of the option they own.
Your job as the option owner is to decide how much that package of Pfizer “goodies” is worth and decide if you want to pay $4,500 to receive it. And you don’t even have to go to the trouble of doing that; the efficient market does that for you. The price at which the option is trading gives you a good idea of what that option is worth. It’s unlikely you will want to exercise your option to buy that package because the right thing to do (almost all the time) is to sell the option when you no longer want to own it.
You are not required to exercise and take that package. The options still trade, just under a new symbol. That means you can sell your option at any time you choose – as long as it’s before the option expires and anyone is willing pay something for it. Just because there was a merger doesn’t mean the option cannot expire worthless in the end.
Brian Overby, TradeKing’s Options Guy, posted not too long ago about non-standard options, which is the name for these hybrid options. He also blogged about what happens to options on bankrupted stocks. Both may be interesting reads for you, too.
Thanks for the great question!
Regards,
Mark Wolfinger
Founder, MDW Options
TradeKing All-Star Commentator
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