Leveraging spinoffs with options

[jmp8822]

Going through a thought exercise right now and was hoping for some feedback.

 

Suppose you expect a spinoff will reveal a mispricing once it is separated. For an extreme example, you expect a $20 pre-spin stock to spinoff at $10 each. ($10 spinoff + $10 parent = $20 pre-spin) You then expect the spinoff to rise from $10 to $20 within a month or so. This would give you a 50-percent return from the pre-spin $20 price, as the total rose to $30.

 

Is there a way to express this view with an option, the desired effect going long only an option on the spinoff? I guess I can't get my mind around how to zero out the parent price movement, attempting to own just the optionality of the spinoff. (Considering you can initially not buy an option on the spinoff, until the options are listed) I guess just the opposite if you want to be short one half of the pre-spin company?

[thepupil]

It all depends on what the strike adjustment to the option will be.

 

For example, if the strike adjustment is based upon the price of the spinoff at the time of spin (and you think that price will be low relative to intrinsic value), then you maybe could do something like

 

Buy stock at $20.

 

Sell $21 call, buy $19 Put. (synthetic short).

 

Then the spin occurs at $10 and $10. If the strike adjustment adjust the parent's stock only (rather than the options becoming options on both stocks which can happen a lot too). then you'd be short an $11 call on the parent and own a $10.00 put on the parent.

 

If the strikes adjust like that, than you could possibly size up bigger in the company pre-spin and have limited exposure to the parent. But there are a ton of variables (whether or not the options will adjust like that, how the strike adjustment will be determined, what price the spinoff comes out at, etc.)

 

hope that made a tiny bit of sense.