448 Part IV: Additional Considerations 
The sale of in-the-money calls as a substitute for shorting the acquiring compa­
ny (XYZ) can be beneficial at certain times. It is necessary to have a plus tick in order 
to sell stock short. When many arbitrageurs are trying to sell a stock short at the same 
time, it may be difficult to sell such stock short. Morever, natural owners of XYZ may 
see the arbitrageurs holding the price down and decide to sell their long stock rather 
than suffer through a possible decline in the stock's price while the merger is in 
progress. Additionally, buyers of XYZ will become very timid, lowering their bids for 
the same reasons. All of this may add up to a situation in which it is very difficult to 
sell the stock short, even if it can be borrowed. The sale of an in-the-money call can 
overcome this difficulty. The call should be deeply in-the-money and not be too long­
term, for the arbitrageur does not want to see XYZ decline below the strike of the 
call. If that happened, he would no longer be hedged; the other side of the arbitrage 
- the long LMN stock - would continue to decline, but he would not have any 
remaining short against the long LMN. 
LIMITS ON THE MERGER 
There is another type of merger for stock that is more difficult to arbitrage, but 
options may prove useful. In some merger situations, the acquiring company (XYZ) 
promises to give the shareholders of the company being acquired (LMN) an amount 
of stock equal to a set dollar price. This amount of stock would be paid even if the 
acquiring company rose or fell moderately in price. If XYZ falls too far, however, it 
cannot pay out an extraordinarily increased number of shares to LMN shareholders, 
so XYZ puts a limit on the maximum number of shares that it will pay for each share 
of LMN stock. Thus, the shareholders ofXYZ are guaranteed that there will be some 
downside buffer in terms of dilution of their company in case XYZ declines, as is 
often the case for an acquiring company. However, ifXYZ declines too far, then LMN 
shareholders will receive less. In return for getting this downside guarantee, XYZ will 
usually also stipulate that there is a minimum amount of shares that they will pay to 
LMN shareholders, even if XYZ stock rises tremendously. Thus, if XYZ should rise 
tremendously in price, then LMN shareholders will do even better than they had 
anticipated. An example will demonstrate this type of merger accord. 
Example: Assume that XYZ is at 50 and it intends to acquire LMN for a stated price 
of $25 per share, as in the previous example. However, instead of merely saying that 
it will exchange two shares of LMN for one share of XYZ, the company says that it 
wants the offer to be worth $25 per share to LMN shareholders as long as XYZ is 
between 45 and 55. Given this information, we can determine the maximum and 
minimum number of shares that LMN shareholders will receive: The maximum is