lystn

Hey everyone, this is Kirk here again at optionalpha.com and welcome back to the daily call. Today, we are going to be answering the question, “Should we trade options after a merger or a buyout is announced?” This is again, a question that came from our community, so thank you so much for submitting your questions to me because it definitely helps out. The reality is that when a merger or a potential buyout of a company is announced, what people typically often think and what typically happens is that the stock now trades dramatically higher based on the agreed upon share price. If company A says that they’re going to buy company B for $10 a share, then the stock immediately starts trading to that. It’s usually a premium. The company is going to buy them for a premium, so that all the shareholders and board members will accept the deal and approve it. Then the stock starts trading immediately higher, but the reality is that even though it had a lot of volatility heading into that event or that one-day event is so volatile, the vast majority of them that are approved and that are going to go all the way through to the closing and the transaction, we’d actually see that the stock price changes very little from that offer price of say $10 a share. Can you trade options around this? Sure, you could, but volatility is going to be almost nothing and so, you’re probably not going to get as much premium out of it as you think you would. Now, the only other times you would want to maybe setup a strategy around this is if you think that there are some sort of uncertainty in either the deal being accepted or there is the potential that other bidders might come into place. If company A says they’re going to buy company B and they’re going to buy it for $10 a share, sometimes we actually might see the stock trading higher than $10 a share and people will ask, “Well, why is it trading higher than $10?” That’s because maybe there's company A which is just the first. Maybe because they offer $10, we might see somebody else now come in and offer $12 or offer $15 a share and we might get a bidding war. We also could see the stock actually trading lower than the share price offer. If the company is offering $10 a share, we might actually see the stock trading at $8 and again, the question is, “Well, why is it trading lower? They’re offering $10?” Well, because we don't know if it has to pass some sort of regulatory hurdle or some sort of approval process that has to go through where the board has to approve it before anything happens or if it’s a hostile takeover. There’s a lot of uncertainty in that as well. I think the reality is that in the case of options trading, yes, you could probably make some plays in that, yes, you could probably trade some things around it if you think one direction is going to be more impactful versus the other. I would say anything that you do in that case has to be pretty much risk defined. I wouldn’t do anything undefined risk as far as trades go. I wouldn’t do any straddles or strangles. If I was going to do anything, I’d do credit spreads or directional spreads and just make a small bet. It’d be a good play or just have fun with it really, but I would not bet the house on doing these types of trades. They don’t come up that often and because they’re so infrequent, there's not too, too much data and every position is independent of one another that I don’t think there’s a consistent framework around how you can trade them. Again, if you want to trade them for one-off type positions, knock yourself out. It’s not something that I do typically at all, but it’s something that you can do if you want to. You just have to understand the context of how the deal is being setup and presented. As always, hopefully this helps out. Until next time, happy trading!