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:

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:

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):

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 ([email protected])