In Part I of this series, we discussed mergers involving cash settlement only. These events do impact our covered call and put-selling positions. In this article we will highlight mergers that involve both cash and stock and demonstrate how these corporate events can alter our option contract positions.
Assumptions
Company XYZ is merging into Company BCI and BCI is paying for each share of XYZ, 1/2 share of BCI + $5.00 per share: 100 XYZ = 50 BCI + $500.00
The $500.00 remains a fixed amount despite any change in share price of BCI by consummation of the merger.
Changing option symbol
XYZ calls and puts will now trade as BCI1 calls and puts and continue to trade until they expire:
Stock + Cash Merger
Calculating the “moneyness” of the $25.00 call strike if BCI is trading at $30.00
The aggregate exercise amount per contract ($25.00 x 100) = $2500.00 both before and after the merger. We know that when BCI1 is exercised, 50 shares of BCI + $500.00 is deliverable. If BCI is trading at $30.00 per share, the current contract value is $1500.00 + $500.00 = $2000.00 or $500.00 less than the aggregate exercise amount. This means that the call is out-of-the-money by $500.00.
Recent example
Eagle Rock Partners, L.P. (“O:EROC”) Merger COMPLETED
with Vanguard Natural Resources, LLC (“O:VNR”)
Shareholders of Eagle Rock Partners, L.P. (“EROC”) voted on Monday, October 5, 2015, and
approved a proposed Merger between EROC and Vanguard Natural Resources, LLC (“VNR”).
Pursuant to the terms of the Merger, each EROC Common Unit outstanding immediately prior to the
consummation of the Merger will be converted into the right to receive 0.185 of a Common Unit of
VNR. The Merger became effective today, Thursday, October 8, 2015.
Contract Adjustments
Pursuant to Article VI, Section 11, of OCC’s By-Laws, all outstanding EROC options shall be
adjusted as follows. On Friday, October 9, 2015 each adjusted Eagle Rock Partners, L.P.
contract will require the receipt or delivery of: (A) 18 Common Units of VNR; plus (B) cash in
lieu of 0.5 fractional Common Unit of VNR. Premiums for the adjusted Eagle Rock Partners, L.P.
options will continue to be calculated on the basis of a multiplier of 100, i.e., for premium and strike price
extensions, 1.00 will equal $100. The Eagle Rock Partners, L.P. option symbol will change to
VNR2. [Any FLEX series that may exist will be adjusted in a similar manner to the standardized
option.]
Discussion
Corporate events like stock splits, special dividends, spinoffs and mergers and acquisitions usually result in option contract adjustments which impact our covered call writing and put-selling positions. These changes are made to make both option buyers and sellers “whole” but we still must understand how are contracts are impacting to then allow us to make the best investment decisions.
Market Tone
Muted economic data led to a rebound in global stocks, as investors expect central banks to extend their low-interest rate policies. Early corporate earnings reports were mixed, although large banks positively surprised. This week’s reports:
- US retail sales increased 0.1% in September. Rising automobile sales offset less expensive gasoline
- The University of Michigan’s preliminary consumer sentiment index rose from 87.2 in September to 92.1 in October
- The gauge of current conditions jumped from 101.2 to 106.7 over the same month.
- US industrial production fell for a second straight month in September, dropping 0.2% after a 0.1% decline in August
- Initial jobless claims fell 7,000 to 255,000 for the week ending October 10th matching a 42-year low
- Continuing claims declined 50,000 to 2.16 million for the week ending October 3rd
- The Consumer Price Index fell 0.2% in September while the core CPI, excluding food and energy prices, rose 0.2%
- Overall, prices were unchanged from a year earlier, but core prices rose 1.9%
- The Producer Price Index fell 0.5% in September, and core PPI dropped 0.3%
- For the year ending in September, the PPI was down 1.1%, while the core PPI was up 0.5%
For the week, the S&P 500 rose by 0.90% for a year to date return of (-) 1.25%.
Summary
IBD: Confirmed uptrend
GMI: 3/6- Sell signal since market close of October 14, 2015
BCI: Cautiously bullish favoring in-the-money strikes 2-to-1
Wishing you the best in investing,