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Mergers and Acquisitions: Part I- All Cash Mergers

Contract adjustments will change our covered call writing and put-selling positions. In the past, I have written about the effect stock splits and dividends have on our positions. In this article, I will highlight another cause of these adjustments, mergers and acquisitions (M&A). This is a corporate event where two companies are joined into one or one company purchases another. In both instances, option contracts will change based on decisions made by panels from the Options Clearing Corporation OCC), with a goal of making option buyers and sellers “whole”. Part I of this two-part series will detail All-Cash Mergers.

 

Terms involved with contract adjustments

Deliverable: The unit of trade, generally 100 shares per contract for unadjusted contracts.

Option symbology: Includes stock symbol, expiration date, “C” or “P” for call or put option and strike price in dollar and cents as shown in the chart below:

option contract adjustments

Makeup of an Option Symbol

 

Aggregate exercise amount (aggregate contract value): This is the total amount paid or received for the deliverable and is generally the strike price x 100. For example, if a $55.00 call or put was bought or sold, the aggregate exercise amount is $5500.00 per contract.

 

Potential modifications to contract terms depending on corporate events

  • Number of shares deliverable
  • Strike price
  • Multiplier
  • Option symbol

 

All-Cash Merger

Let’s assume Company XYZ is merging into BCI and BCI is paying $55.00 per share for every share of XYZ. For every 100 shares owned post-merger, the shareholder will receive $5500.00. Prior to the merger, shares of XYZ changes hands, not cash. Upon consummation of the merger, trading of the XYZ stock and options halt simultaneously and exercise of XYZ calls and puts are based on the OCC’s cash settlement system where all in-the-money strikes have value and at-the-money and out-of-the-money strikes have no value. More on this later. The following screenshot breaks down the option status before and after the cash merger:

contract adjustments for options

All-Cash Merger

 

The effective date is the day after the consummation date and option contracts will be cash-settled. For example, if XYZ was trading at $60.00, the cash deliverable for the $55.00 call option is $6000.00, $500.00 more than the aggregate contract value. Cash settlement for this, now, in-the-money strike is $500.00. All strikes at-the-money or out-of-the-money expire worthless (the chart below shows both call and put options):

contract adjustments and covered call writing

All-Cash Mergers-Settlement

 

Discussion

It is important to understand how corporate events can alter our option-selling positions. Contract adjustments are determined by OCC panels and are changed based on the specific terms of the event. In Part II of this series, we will be detailing Stock and Cash mergers. More information on specific mergers can be gleaned from our brokers or by calling the OCC at 1-888-678-4667.

For more information on contract adjustments:

Complete Encyclopedia for Covered Call Writing- Classic:

Pages 193 – 196

Pages 323 – 332

Complete Encyclopedia for Covered Call Writing- Volume 2:

Pages 179 – 183

Pages 299 – 308

 

Department of Labor Update

A large group of Congressional Republicans recently sent a letter to the Department of Labor asking them not to restrict the financial advice offered by fiduciaries as related to investments in sheltered accounts. Most of us do not depend on the advice of financial advisors but there are many retail investors who do depend on wealth managers for option-related investments who may be impacted by DOL proposed regulations for these fiduciaries. As I receive more information from my contacts I will pass it along to our members.

 

Next live appearance

Milburn, New Jersey

October 13, 2015

6:45 PM – 8:30 PM

For information

 

Market tone

Global and US markets rebounded this week, relieved that September’s disappointing payrolls report as well as  weak US, UK and German export data could mean low US interest rates. The Chicago Board Options Volatility Index (VIX) fell below 18, reflecting improved investor confidence and ending its first month-long stretch above 20 since 2012. This week’s reports:

  • Fed officials held back from raising short-term interest rates at their September policy meeting because of concerns that global weakness could impact the US economy, according to minutes released Thursday. The officials were also concerned about persistently low inflation
  • US exports fell 2% in August while imports rose 1.2%, resulting in the US trade deficit widening 15.6% to $48.3 billion. The strong US dollar and weak demand in foreign markets contributed to the growing trade gap
  • US import prices fell 0.1% in September, less than the expected 0.5% decrease
  • Prices for imported oil rose 1.1% while non-oil import prices declined 0.2%, half the pace of contraction in July and August
  • Export prices fell 0.7%.
  • The Institute for Supply Management’s non-manufacturing index fell from 59.0 in August to 56.9 in September
  • The business activity index, a gauge of services production, declined from 63.9 in August to 60.2 in September. Both measures indicate continued expansion, but at a slower pace than in the previous month
  • Initial jobless claims fell 13,000 to 263,000 for the week ending October 3rd, near a 42-year low
  • Continuing claims rose 9,000 to 2.2 million for the week ending September 26th

For the week, the S&P 500 rose by 3.26%% for a year to date return of (-) 2.14%.

Summary

IBD: Confirmed uptrend

GMI: 3/6- Sell signal since market close of August 24, 2015

BCI: Maintaining a cautious but fully-invested portfolio of in-the-money calls and out-of-the-money puts.

Wishing you the best in investing,

Alan (alan@thebluecollarinvestor.com)

 

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

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16 Responses to “Mergers and Acquisitions: Part I- All Cash Mergers”

  1. Stu October 10, 2015 6:31 am #

    Alan,

    I’m curious why you are not adding otm strikes since the market had a good week.

    • Alan Ellman October 10, 2015 9:21 am #

      Stu,

      The market did have an encouraging week but it is only one week. Also, we are entering the final week of the October contracts. If we have another positive week, I will most likely add some more aggressive positions to my November portfolio.

      Alan

  2. Alan Ellman October 10, 2015 9:38 am #

    BCI Contest?

    One of our members (Jay) suggested a BCI contest to take the pulse of our membership regarding perhaps predictions of future market levels etc. I liked this concept but wanted to hear from our members regarding your ideas and feedback. Do you think this is a productive idea? What contest goals will stimulate helpful dialogue? Any other suggestions? Send ideas and comments to:

    alan@thebluecollarinvestor.com

    Thanks to Jay for initiating this idea.

    Alan

    • Jay October 10, 2015 11:04 am #

      Good morning Alan,

      Thanks for the kind post and request for feedback. I do not know either if such a contest would be helpful or just fun !?

      I do know I read many smart posts from smart people here and my hunch is we can come up with something. Even if it is just the year end S&P close, a favorite Wall Street game :).

      Kind regards, – Jay

  3. Barry B October 11, 2015 12:32 am #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 10/09/15.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Since we are entering Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:

    https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/

    Best,

    Barry and The BCI Team

  4. David October 11, 2015 3:23 am #

    Alan,

    Could you please give an example of how to calculate the 20% /10% with a ITM call & how you place the limit order to BTC if limit price is reached.

    Thank you.
    David

    • Alan Ellman October 11, 2015 8:11 am #

      David,

      Glad to:

      Buy BCI @ $42.00

      STO the $40 (ITM) call @ $3.50

      Now the trade is executed and we can immediately set up a limit order to buy back the option:

      BTC the $40 call @ $0.70 (20%) in the first half of the contract

      In the 3rd week of a 4-week contract and in the 4th week of a 5-week contract change to $0.35 (10%).

      This will automate the option buyback when needed. If the trade is executed we can then decide our next step based on the information provided in my books and DVDs.

      Alan

  5. Sally October 11, 2015 10:51 am #

    Hi Alan,

    Have you ever considered setting up a forum for members only?

    I know you have members worldwide so it would be a good opportunity for members to introduce themselves, discuss their current trades etc.

    Thankyou,
    Sally

    • Alan Ellman October 12, 2015 7:27 am #

      Sally,

      Yes, this is on our ‘to-do” list (pretty long now as our membership has been increasing so fast with ideas and suggestions coming in on a regular basis…thanks to all for that). It will require a moderator and that is the part we are figuring out. For now, the blog is open to comments and ideas outside the article topic. Thanks for the feedback

      Alan

  6. Barry B October 11, 2015 7:42 pm #

    Premium Members,

    The Weekly Report and Watch List has been revised and uploaded. The change was due to an ER change in HAWK. Please look for the report dated 10/09/15 RevB. No other stocks were impacted by the update.

    Thanks to John for finding the change.

    Best,

    Barry and The Blue Collar Investor Team

    • Nate October 12, 2015 9:10 am #

      Thanks Barry for the revision. Also thanks John for finding out about HAWK.

      I just so happen to be in a HAWK position. HAWK Oct15 40 Covered Call. The profit is up nicely for only being in for ten days. Now that I am aware that earnings are tomorrow after the close. I will just close this position and lock in that profit and avoid the extra risk.

      For those in a HAWK position I suggest you take a look at doing some sort of adjustment because earnings come out this Tuesday (10/13/15) after market close, before expiration.

      • Roni October 12, 2015 11:58 am #

        Nate,
        nice trade.
        Excelent decision to close before ER.
        Good advice to members.
        Thanks – Roni

    • Roni October 12, 2015 11:48 am #

      Thank you Barry,
      I was wondering about this revision.
      Roni

      • Barry B October 12, 2015 10:05 pm #

        Roni,

        I’m glad I could help.

        Barry

  7. Roseann October 12, 2015 1:08 pm #

    Alan,

    Do you know of a free site for reliable put-call ratio statistics?

    Thank you,
    Roseann

    • Alan Ellman October 12, 2015 2:08 pm #

      Roseann,

      A free, reliable site to access put/call stats:

      http://www.optionsclearing.com/

      Market data

      Volume

      Volume query

      Enter symbol and expiration date

      “Submit query”

      Below is an example of the search results. CLICK ON IMAGE TON ENLARGE & USE THE BACK ARROW TO RETURN TO THIS BLOG.

      Alan

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