Call options give the holder the right, but not the obligation, to purchase shares or other financial assets. As such, the higher the value of the underlying stock, the more valuable the call option. When the company whose shares constitute the deliverable assets of a call option is bought, the value of the option will usually rise. Depending on the timing of the sale, the options may also terminate early.
A call option is a legally binding financial contract that gives the holder the right, but not the obligation, to buy shares or other assets such as gold or treasury bonds, at a predetermined price and time. A call option on publicly traded XYZ shares, for instance, may specify a strike price of $9 for January 30th and cover 100 shares. This means that the holder can force the option originator to sell 100 shares of the stock at $9 each on January 30th. If the market price of the same stock is $13, the options holder can immediately sell the same shares for a $4 profit per piece and make $400.
Public companies, even the largest ones, are subject to buyouts, which can be amicable or forced. A buyout occurs when one firm purchases sufficient number of shares of another company to gain control. To do so, an offer is usually made where the buyer offers either cash, its own stock or a combination of the two. Each share of Company X may trade at $20 for instance, while each share of Company Y goes for around $8. Company X may announce that it offers $10 cash for each stock of Company Y to entice stockholders to sell their holdings. If it does not have sufficient cash at hand, the same firm can also offer 1 share of its own for each two shares of Company Y, which will result in the same net gain for shareholders of Company Y.
Each buyout has an effective date. The buying entity may announce that it will pay the said price for each share of the other firm on January 24th, for example. There is usually several weeks between the announcement of a buyout offer and the effective date, to allow stockholders to evaluate the offer. If the option expires prior to the effective buyout date, no specific action needs to be taken by either the option buyer or the seller. If the buyout is completed and the shares of the acquired firm cease to exist because it merges with the acquirer, prior to the option expiration date, the options will be priced according to the acquisition price and terminated.
Assume that you hold an XYZ $9 call option for January 30th, covering 100 shares and that XYZ is acquired for $10 per share and ceases to trade in the stock exchange as an independent firm as of January 29th. In this case, you will be paid $100 on January 29th, and your options will cease to exist.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.