Stockholders of First Midwest Bank are most likely happy about the pending merger with Old National, as they’ll be getting 1.1336 Old National shares for every First Midwest share they own. Mergers typically benefit shareholders of the purchased company, but the same doesn’t hold true for those who hold options in a company. So, what happens to options in a merger?
Options are different from stocks
Owning an option in a company is different than owning stock. Whereas stock gives you ownership of a piece of a company, an option is a contract that allows you to buy or sell the stock at a specific price and date. Each option is worth 100 shares.
As the option buyer, you set the price, or strike price, that you want the option to reach by its expiration date. If the strike price is higher than the market value, then it’s a call option. If it’s lower than market value, it’s a put option. You also set the expiration date, aiming for a date when the stock hits its strike price.
Why do people buy options?
Investors buy options because they're less expensive than stocks but can deliver higher returns. But if the option expires before the stock reaches the strike price, you could end up with nothing, losing both what you paid for the option and the value of the stock.
What happens to options in a merger?
When a company buys out another company, they do so in one of three ways: an all-cash buyout, an all-stock buyout, or a combination stock plus cash buyout. Whether the buyout benefits the option holder depends on the option's strike price and the price being paid in the buyout.
What happens to options in an all-cash buyout?
In an all-cash buyout, investors in the company being purchased are paid for their shares in the company. Those holding call options can make some money if the amount offered is above the option's strike price.
For example, if you own a call option (which is worth 100 shares) with a strike price of $40 and the buyout is giving $60 per share, you would make $2,000 from your option. However, if you have a strike price of $70 on your option, you would get nothing.
The reverse is true if you own a put option. For example, if you own a put option with a strike price of $40 and the buyout is giving you $60, you’ll get nothing. But if your strike price is $70, you’ll make $1,000.
What happens to options in an all-stock buyout?
In an all-stock buyout, the companies trade stock for stock. Options on the purchased company are exchanged for options on the buying company’s stock at the same strike price but for a different number of shares.
For example, Company X buys Company Y and exchanges each share of Y for a half share in X. Options on Y stock would be exchanged for options on X, but when an option is exercised, the holder would get 50 shares of stock rather than 100.
What happens to options in a stock plus cash buyout?
In a stock plus cash transaction, the buying company gives shareholders part stock and part cash for their shares in the purchased company. For example, when Company X buys Company Y, it will give Y shareholders a half share in X plus $3 for each share they own. After the merger is finalized, a call option for Y would require X to deliver 50 shares plus $300 ($3 × 100 shares) if the call is exercised.