What happens to option holders in cases of acquisitions?

M

Monorail

I've googled this, but found the answers frustratingly inconsistent -- most articles just say "ask your broker", which I find to be a pretty wishy-washy answer...figured there'd be hard and fast rules on this, no? FWIW, I've been following the ups and downs of canadian gaming company Amaya Inc (TSX: AYA), currently trading around $18. CEO just announced non-binding intent to take company private for $21/sh...which may or may not come to fruition (hence still trading at $18), but I'm trying to understand what this means for option-holders if this goes through, mainly:
  • Do ITM calls/puts just get auto-exercised on the date of the transaction for their intrinsic value, and any out-of-the-money options simply expire worthless?
  • Doesn't this wreak havoc on the extrinsic time-value premium of the options with distant expiry dates? i.e. if a buyout simply results in holders receiving any ITM amount at time the transaction is finalized, doesn't that destroy any time-value premium of an option expiring well after the anticipated transaction date? i.e. wouldn't the prices of March '16 calls and November '16 calls start to converge?
 
In the case of a corporate action, the OCC will have a bulletin on the website that prescribes what is to happen. Theocc.com
 
Right but I'm asking what's typical in cases like this. That would seem to be a rather important question for anyone looking to buy or sell options in a company where a corporate action is in the immediate future. "Check the OCC website once the acquisition actually takes place" doesn't really help there...
 
In general, if it's a stock deal, or stock plus cash, the option will adjust with the deal. Instead of getting 100 shares of the stock A, each option will be worth whatever the tender is for. If it's a cash deal and their is no stock, the option will settle for cash if in the money based on the cash tender price. EG, your example... If the deal goes though at 21/shares all options will be converted to their intrinsic value based on a stock price of 21.
 
Monorail said:
Right but I'm asking what's typical in cases like this. That would seem to be a rather important question for anyone looking to buy or sell options in a company where a corporate action is in the immediate future. "Check the OCC website once the acquisition actually takes place" doesn't really help there...
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What rmorse wrote looks fine to me; but I'd like to add that the OCC stuff is generally posted far in advance of corporate actions (when they're public knowledge, of course).

In general, I think it's safe to say that the OCC does "something sensible" with the options in these types of cases -- or at least they try. If you want to know in more detail, then you can look at the OCC bulletins yourself -- they're archived going back many years, and they tell you both the publication date (of the bulletin) and the date of the corporate action.
 
OK, so at first glance it appears that the answer to my first Q is indeed that any ITM options will just get liquidated at their intrinsic / ITM value.

But I suppose my 2nd question (about the time-value premium) remains and would seem to be just as convoluted as I suspected, right? If an acquisition is going to basically nuke any remaining time value in an option contract, this really screws holders of calls expiring in the distant future (after the contemplated date of the transaction), right?
 
I'm talking about the time value that is a part of the premium paid for an option right now (while buyout has simply been proposed, but is not 100% certain to be consummated). A Nov '16 $30 Call, for example, has a higher premium than a March '16 $30 Call because of the much longer time horizon (aka more time-value). But if a potential all-cash buyout is proposed that could take place as early as March/April, it really screws holders of longer-term option contracts, because their value will be reduced to only their intrinsic value (if any). Which, as you point out, eliminates any time-value contribution to the premium.
Just want to make sure I'm thinking about this correctly...
 
Monorail said:
I'm talking about the time value that is a part of the premium paid for an option right now (while buyout has simply been proposed, but is not 100% certain to be consummated). A Nov '16 $30 Call, for example, has a higher premium than a March '16 $30 Call because of the much longer time horizon (aka more time-value). But if a potential all-cash buyout is proposed that could take place as early as March/April, it really screws holders of longer-term option contracts, because their value will be reduced to only their intrinsic value (if any). Which, as you point out, eliminates any time-value contribution to the premium.
Just want to make sure I'm thinking about this correctly...
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You are thinking about it correctly except you're assuming the corporate action is a done deal. If it's 100% going to happen, then the option would no longer have time value. But if, as is usually the case, there is the potential that the deal falls apart or someone comes in with a higher offer, then there is still optionality there and that is still priced into the option. Clearly you're not going to use a BS model to price that, so there isn't strictly a "time" value, but there is an optionality value in that you're buying/selling a potential outcome. I'd guess that this would be closely tied to the arbitrage spread on the deal. Usually a company that is to be acquired never trades at the acquisition value, it generally trades lower to price in the risk that the deal will bust and sometimes trades higher if there is an expectation that a bidding war will happen.
 
Thank you, that was helpful. (And yes, AYA is trading at $19 even though the non-binding proposal on the table is for $21, so I assumed the discount was to reflect possibility it may not happen.)
I'm interested to see how this all plays out in the options arena...I'd always presumed that market-makers set their bid/ask spreads algorithmically as a function of the standard option-valuation inputs, but seems like they'd be leaving themselves open to massive exploitation if they didn't have a way to account for corporate actions. Indeed, looking at the July 2016 Calls (furthest time-horizon for which there are contracts), there's currently no Bid even being quoted on any of the Calls higher than the $20.00s, even though the open interest for the July $22 Calls stands at 400. (The Bid stood at ~$1.10 before the $21 offer was announced). So it seems like the MM's have indeed adjusted.

(On that last point, not to get too nitty, but I was under the impression that market makers have a legal obligation to provide for a functioning marketplace, though I guess I don't know what that actually means in practice vis-a-vis fluid situations like this one...I mean, it's reasonable that a MM shouldn't have to post any live bid, say, on the afternoon of an option's expiration if it's far OTM...but it doesn't seem quite as clear-cut for this situation. I mean, for the same reasons that the underlying is still trading at a discount to the $21 offer -- there's a decent chance it falls through -- it stands to reason that there's still SOME extrinsic value to the July $22 Calls, but those option-holders are SOL without any Bids...)
 
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