How anticipated adjustment option will influence option positions?

V

velkyinvestor

Hello,

I would like to ask you, if you could please explain me how this event will affect my short put positions.
Here is OCC description: https://www.theocc.com/webapps/info...e=201812&lastModifiedDate=12/06/2018+00:00:00

I have several SELL PUT positions, LONG CALLs, LONG and SHORT stock positions of DVMT.
Probably I understand what happens with LONG and SHORT CALL, or LONG STOCK, but have no idea how this affects SHORT PUT or SHORT STOCK.

Many thanks in advance
 
The adjustment should be the same, regardless of long/short call/put. A put with 110 strike becomes the right to sell between 150 and 181 shares of Dell (plus a small amount of cash for fractional shares) for $11000. In this case, you'll probably want to exercise long in the money calls prior to the election deadline, and should expect to be assigned early if you have any short in the money calls expiring in the next several months.

My understanding is that the treatment of short stock is governed by the lending agreement between your broker and their counterparty, not the OCC. I'd be interested to hear what your broker says if you do contact them.
 
Very risky to put on positions in the Jan 2019 + options (esp selling puts) because:

1) you don't know what the ratio will be (how many Dell shares)

2) You will end up long the new Dell stock (if you are short deep puts) which doesn't start trading until Dec 28th (I believe)

This is why there are huge spreads in the deep puts. You have to remember that all adjustments settle to what the"non electing shareholders" will receive - so this will not be the $120 cash election and this is why there is a huge discount. Many deals are like this but this one is implying a large discount (lower price for the new Dell stock). I read a decent article on a Seeking Alpha which explains it well.

And yes it appears that many will exercise deep calls and then elect to receive cash (subject to proration)

One of the more interesting adjustments I have seen. Be careful
 
Thanks a lot guys I appreciate it. Yes, my positions are for January, then I should watch it, or at least ask broker about shorting, and be prepared for possible exercising of my short put positions. And yes, I need to think about what to do with my calls, as I receive something which can be traded from 28th Dec.
 
It's unlikely the puts would be exercised, only the calls should be. The market doesn't think the new Dell shares are worth very much, so most of the value of DVMT is in the $120 cash payment. A put holder would rather wait so they can deliver the lower value Dell shares.

Here's a rough breakdown of the valuation:
From the press release, "If all stockholders elect to receive cash, then all stockholders will receive $70.23 per share in cash and a number of shares equal to 41% multiplied by the exchange ratio." Dell stock is expected to be well under $104.55, so the exchange ratio should be 1.813. So shareholders receive $70.23 cash and 0.743 shares of Dell. At $105 per share for DVMT, the expected price of Dell shares comes out to be $46.78. In reality some fraction of shareholders won't elect cash, so the implied price of Dell is probably a bit less.

The deliverable for the options will likely be 1.813 shares of Dell, currently valued at $84.8. If you have calls with $100 strike, you can exercise them now and pocket $5, otherwise if you wait until after the election they'll be $15 out of the money.

If you think the implied price of $46.78 is too low and you want to bet on it going higher, you shouldn't hang on to in the money calls or elect to receive stock with your DVMT shares (unless there are tax considerations). Instead, you should buy the January 120 synthetics (long call, short put). These have been trading a good bit the last few days for around a $35 credit. This is effectively like buying DVMT at $85 rather than the market price of $105, with the caveat that you are electing to receive stock.
 
One other caveat is that margin requirements could be substantially higher while the adjustment is being determined. Some positions might need to be fully cash-secured, and you might not receive credit for offsetting risk between stock and options.
 
elt894:

great responses. You are on top of the adjustments. (and margin increases that take place after an adjustment)

Also saw some of those synthetics (Jan 120). Puts will not get assigned prior for obvious reasons. Really not the type of merger I get involved in because of the risk. But the type (when the compensation is different between electing/non electing shareholders) that can be very profitable if you understand how the options will settle. Spreads often wide in these mergers so there are opportunities.

best of luck
 
Thanks mskl. Do you mean profitable if you can earn the large spread? I generally stay away from these as well but usually feel compelled to double check that nothing is blatantly mispriced. Haven't seen that happen though.
 
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