As a trader, you will sometimes face particular challenges, like figuring out what happens to options when a company is acquired. This process can impact stock options (both calls and puts), at various stages. What happens to call options when a company is acquired? And what about puts? Let us answer all these questions.
Key takeaways
- When a company is acquired, your options will have an immediate price change impact following the underlying stock value.
- Acquisitions affect stock options at different stages, such as during the announcement of the offer and after the completion of the purchase.
- Regulatory bodies like the OCC in the US ensure fair treatment for investors during such transitions.
What Happens to Options When a Company Is Acquired
When a company is acquired, stock options experience an immediate price shift based on changes in the underlying stock’s value. Typically, once an acquisition is announced, the stock price of the target company adjusts toward the agreed purchase price per share. This alignment reflects the expectations that the deal will go through at that value.
For example, if the buying company offers $50 per share and the stock was trading at $40 before the announcement, the share price may quickly climb closer to $50. The market reacts to the news, factoring in both the probability of the deal closing and any regulatory approvals still required.
Once the acquisition is finalized, what happens to stock options when a company is acquired largely depends on the terms of the deal. So, what happens to options when a company is acquired? Here’s what might occur:
- Options Become Cash-Settled: If the shares are bought out for cash, your options may be automatically closed out. The value of your options will be determined by the difference between the exercise price and the acquisition price.
- Options Convert to New Company Options: If the deal involves stock swaps, your options in the original company might be replaced with options tied to the acquiring company’s shares. These will reflect the agreed exchange ratio in the merger terms.
- Options Are Rendered Invalid: If no special provisions are made, unexercised options can expire worthless once the targeted company ceases to exist.
Investors in the US benefit from oversight by the OCC (Options Clearing Corporation). The OCC ensures fairness during these transitions by issuing detailed memos. These memos explain the specific adjustments to be applied to options contracts, including strike prices and expiration terms.
What Happens to Call Options When a Company Is Acquired?
So, let’s begin with the effect of a company acquisition on call options. When the purchase offer is higher than the current market value of the stock, the price of a call option tends to rise. For instance, if the stock was trading at $40 and the buyout offer is $50 per share, a call option (such as those you may find on our options screening service) with a $45 strike price suddenly becomes more valuable. This reflects the increased likelihood of exercising the option profitably.
Another aspect to consider is that implied volatility (IV) in the call option usually drops. Why? Because the market assumes the stock price will stabilize around the offer price (assuming, of course, that the purchase offer is credible), meaning big price swings are less likely in the short term. For example, if $50 per share is widely accepted as the final price, there’s less chance of significant upward or downward movement without any major unexpected event.
Notice that the two factors move in the opposite direction in our example:
- The fact that the underlying price increases from $40 to $50 surely has a positive impact on the option price.
- However, this rise can occur with a drop in implied volatility, which will have a negative effect on the call price.
- Which of the two factors prevails? That’s hard to say: we have seen both cases in the past. Sometimes, the price increase of the underlying stock is so large that the IV drop cannot compensate for its positive effect on call options (or vice versa).
Also, the call option value might decrease if the acquisition offer is below the current market price. But at this point, the market may not even judge the offer to be credible, so the decline in price may just be temporary.
For options traders, these shifts are critical. Suppose you’ve purchased a call option assuming a merger will boost the stock price. A lower-than-expected offer could reduce your potential gains, while market stability after the announcement might lower the premium you initially paid. Accurately assessing these scenarios helps protect your investments and adapt your strategies effectively.
What Happens to Put Options When a Company Is Acquired?
We have just told you about calls, so it will now be easier to understand what happens to puts. When a company is acquired, the price of a put option generally drops if the purchase offer is higher than the current market price. For example, if a stock was trading at $40 and the offer is $50 per share, the likelihood of the stock falling below the put’s strike price significantly decreases, reducing its value.
Similar to call options, implied volatility often declines if the market views the offer as credible. With the expectation that the stock price will stabilize around the agreed-upon offer, traders anticipate fewer price fluctuations in the short term, which lowers the premiums on both calls and puts.
However, not all offers are favorable. A lower-than-expected or uncertain acquisition offer can increase put option values. This occurs when investors suspect the deal may fall through or if they believe the stock price could drop further. For instance, if the offer is $35 while the stock was already trading at $40, the market might react negatively, increasing demand for protective puts.
Of course, in the latter case, you still have to take into account the negative impact of a decline in implied volatility: your put might still lose in value, despite the underlying stock price decline.
So there it is: we told you what happens to stock options when a company is acquired, so keep in mind that calls and puts will react differently, and that the OCC will generally have the final say on the operation if the purchased company is based in the US.
