1. About Options in a Buyout
2. Call Options and Buyouts
3. Types of Buyout Offers

About Options in a Buyout

A situation that results in a buyout includes a merger, which involves at least two companies. This could result in one company being dissolved and a new business being formed. Before a merger can commence, the board of directors for all companies involved must approve the merger transaction.

Some states may require the approval of the shareholders before a merger can take place. During a merger, the stockholders may receive cash, stock, or both cash and stock.

The announcement of a buyout by another company is often deemed beneficial for shareholders of the company being purchased. This is because the offer is generally at a premium price compared to the market value in place prior to the announcement.

Call Options and Buyouts

There is the situation where call option holders may or may not be in a favorable position. This depends on the strike price (set price) assigned to the options they hold and the price being paid in the buyout.

  • Call options give the person holding the option the right to purchase at a set price any time before the options expire. This is assuming these are American options.
  • In effect, a call option would not be exercised to purchase shares at the set price if the set price had a higher price than that of the current market price.
  • When a buyout offer is made where a set amount for each share is offered, it limits how high the shares can go. This is assuming no other offers will be made, and the initial offer will most likely be accepted.

If the offer price is below the strike price (set price) of the call option, there is a good possibility the option will lose a good portion of its value. On the reverse side, when the strike price is below the offer price, there can be a moderate to significant increase in its value. For example, if a buyout offer is received for $80 per share and the call option is $70, the shareholder will make money. If the call option is $90, the shareholder will lose money.

It is recommended that if the stock price is high enough before the settlement date to cash out. Once the buyout occurs, whatever you have in place is final. Or, the company that initiated the buyout may adjust the stock options as long as it was not a cash buyout.

In general, there are nearly no good reasons for shareholders to retain short-term call options throughout the buyout process. This is due to the net win or loss already being attained prior to the completion of the buyout.

When the buyout occurs, and the options are restructured, the value of the options before the buyout takes place is deducted from the price of the option during adjustment. This means the options will become worthless during the adjustment if you bought out of the money options.

Types of Buyout Offers

  • All-Stock Offer: Companies involved with a stock-for-stock merger have agreed to exchange shares based on a set ratio. The number of shares in a call option is updated, adjusting for the buyout value.
  • All-Cash Buyout: This refers to a company bought for a cash price per share. In this case, the options are valued for a cash settlement of the effective date of the buyout.
  • Stock Plus Cash Buyout: With this type of buyout, there is a change with the covered stock of the purchased company, the number of shares to be delivered, and a cash amount. For example, the buying company is swapping 1/2 of a share of the company plus $3 for each share of the company being purchased. Based on 100 shares, once the merger is finalized, a call option for the company that was bought would require the buying company to deliver 50 shares (of its shares) plus $300 ($3 x 100 shares) if the call is exercised by the buyer.
  • Reverse Merger: This occurs when a public company acquires a private company. The result is the exchange of shares by the shareholders and management for a controlling interest in the company.

If you need help with what happens to options in a buyout, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.