Let's say for the sake of the question you're given the following scenario:
- Company BIG is trading at $10/share
- Company SML is trading at $40/share
- BIG reaches an agreement with SML for an all stock acquisition/merger whereas SML shareholders will receive 5 shares of BIG for each share they own
How would a call option in SML be affected by this deal?
Specifically, I'm unsure of the following:
- How is the strike price for SML options affected by the merger? I've read that the only thing that would change is the deliverable (i.e. instead of receiving 100 shares in SML when exercising, you'd now receive 500), but this result in SML contracts having inflated strike prices due to the difference in the value per share pre-merger...
- What happens to out of the money SML options? I've read that they'd instantly become worthless... wouldn't this only apply to an all-cash deal? If the deal involved a transfer of shares, wouldn't the contract be adjusted based on the terms of the deal with the deliverable changing from shares of SML to shares of BIG?
- Assuming the deliverable for the SML options are converted to shares of BIG, how are these converted contracts traded... in other words, are they liquid or only useful if you decide to exercise them?
I just started trading options a few weeks ago and haven't been able to find answers to these questions anywhere... any help from an experienced trader would be much appreciated!