What Happens to Short Call Options During a Buyout?

by Hunkar Ozyasar

    If you are short a call option, you have the obligation to sell another investor the asset specified in the option contract at a specific price and on a particular date. If the option involves selling a particular stock and the company that issues the stock is purchased by another corporation, the stock may go out of existence before the date specified in the option contract. In this case, special clauses will be triggered, which you should thoroughly understand before you short options.

    Call Option Basics

    A call option gives the holder the right, but not the obligation, to purchase an asset. Call options have an underlying asset, strike price, expiration date and specified quantity for the underlying asset. For example, a call option may be for IBM stock, at $30, expiring Dec. 1, and for 100 shares. This means that the person who owns this option has the right to buy 100 IBM shares from the individual who wrote the option for $30 per share, on Dec. 1. The person who wrote the option is also referred to as "being short" the call option. If you are short a call option, you may therefore be asked to come up with shares and sell them at a particular price and date.

    Buyout

    A buyout might present a logistical problem for both the option holder and the party who is short the option. In most, but not necessarily all, buyouts, the stock of the firm that is bought is delisted. In other words, the stock may go out of existence. If Company A buys all outstanding shares of Company B, the shares of Company B will no longer be traded in the stock market, since Company A will keep all shares of B for itself and may even merge the acquired firm into its corporate structure as a new department. This raises the question of how you can find and sell shares if you were short a call option.

    Cash Buyouts

    If one company purchases another corporation for cash, call options are settled for cash if the takeover price exceeds the option's strike price. Assume a company buys all outstanding IBM shares for $35 per share before Dec. 1. This would usually involve making a public announcement that the acquiring company is willing to pay $35 per share for IBM stock to all investors who submit their shares to the acquiring firm. If such an event occurs before Dec. 1, the person who is short the option would be responsible for delivering $5 times 100 to the option's holder. This is because the option holder can profit $5 per share by buying them from the option writer for $30 and selling them for $35 a piece. To streamline the logistics, the option's writer can just pay the $500 in cash.

    Stock Offer

    A company can also purchase the shares of another by paying with its own shares. For example, ABC Corp. can pay, for each IBM share, two of its own shares. So an investor can submit 100 IBM shares and receive 200 shares of ABC Corp. If this exchange occurs and there are no more IBM shares trading as of the expiration, the option's writer has the obligation to sell 200 shares of ABC Corp. for the exact same total price that has been specified for 100 IBM shares.

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    About the Author

    Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.

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