When one company purchases another in New York, the shareholders oftentimes have cause to celebrate. This is because the offered price is usually at a premium to the fair market value of the business. However, some people who hold call options might not look so favorably at the business move if their option’s strike price falls within a certain threshold.
What do call options do?
With a call option, holders have the right to buy stock shares at a set price as long as they get to them before their expiration date. Stockholders have the potential to make a profit if the takeover price exceeds the strike. But if your option’s strike price is more than what the takeover or market price is at any point, your option expires without having any worth.
Once the merger is official, these out-of-the-money or OTM securities have no value anymore. The way to determine if an option is out-of-the-money or not is usually by evaluating the final closing price of the stock.
What makes a merger favorable or not?
With mergers and acquisitions, the two companies now become a single entity. This may mean bad news for trading options because it puts an end to these previous entities.
One of the key factors that play into how favorable a buyout can be is your option’s strike price. This refers to the price at which your call option is able to be exercised. Another crucial element is how much money the offer entails.
Call options are contracts that endow option purchases with the ability to purchase underlying assets at a set cost for a certain period of time. OTM securities are options that don’t have any intrinsic value, and they can’t be traded in after the merger. If the call option’s strike price exceeds the current price on the market, they fall into the OTM category and lose its value once the merger is made official.