Call Options on Merger Deals

[Guest roark33]

This is a crazy idea and probably not good for this board, but, has anyone ever looked at selling calls on options above the merger price.  You wouldn't think it exists, but it does occasionally.  You are basically short the stock at or slightly above (due to the call premium) at the merger price. I presume option buyer thinks there might be a topping bid or the merger would break and the stock will trade higher.  Both of these are rare, especially after 30 days or so when the company has been further "shopped".  For example, you can sell calls on RHT at 190 for 40 cents in January 2020. The deal should be done in the fall, so the options will expire early.  Obviously, picking up nickels in front of a steam-roller, but is kind of an interesting idea to think about. 

[bizaro86]

This is a crazy idea and probably not good for this board, but, has anyone ever looked at selling calls on options above the merger price.  You wouldn't thi

nk it exists, but it does occasionally.  You are basically short the stock at or slightly above (due to the call premium) at the merger price. I presume option buyer thinks there might be a topping bid or the merger would break and the stock will trade higher.  Both of these are rare, especially after 30 days or so when the company has been further "shopped".  For example, you can sell calls on RHT at 190 for 40 cents in January 2020. The deal should be done in the fall, so the options will expire early.  Obviously, picking up nickels in front of a steam-roller, but is kind of an interesting idea to think about.

 

I have done that once or twice when I already owned the underlying as a merger arb and didn't think a topping bid was likely. Those were covered calls where I was trading potential upside for a bit wider spread.

 

To sell naked calls on merger stocks seems like a spectacularly good way to go broke to me. It'll generate nice profits right up until you get crushed.

[writser]

To sell naked calls on merger stocks seems like a spectacularly good way to go broke to me. It'll generate nice profits right up until you get crushed.

 

+1. I agree that the chances of an overbid appearing for RHT are very close to zero. But if it happens you are easily looking at a 50x loss? If I were to be comfortable with that my position in the puts would be so small that it would probably not worthwhile, both from an emotional and a financial perspective. I would prefer to be long the optionality of an unexpected higher bid - not levered short to make 0.2% / share.

[thepupil]

you would have to cap losses. Selling the 190's for 0.40 cents seems insane, but selling the 190 195 spread for 0.35 is probably hugely expected value positive. My issue is I question if there are enough of these situations to build a big enough book such that the blow up where you lose 12x your profit doesn't wipe it all way. I imagine somewhere at some multi-strate fund or susquehanna or something where they can execute well, they do this systematically and it makes a lot of money.

[Guest roark33]

I agree with all of your points.  I don't think this would be an everyday thing, but with the occasional deal that is 4 months old and there is no topping bid in sight (Red Hat) and where a huge premium is involved, I think it might make sense.  still thinking about it. 

[Pelagic]

Maybe someone here knows, what kind of model do market makers use to price options above the buyout price? Personally, I kind of like the other side of the trade constructing a portfolio of longshot calls that are above the buyout price in the hopes of a topping bid but if I've learned anything about options markets it's that the market makers that price them are pretty good at it so I'm not sure I'd have any insight into the trade to determine whether or not the options are being priced correctly. Simply buying or selling them without any additional insight for the sake of optionality or premium seems like it'd be a breakeven strategy (minus trading costs/slippage) if you did it often enough.