39 lines
3.1 KiB
Plaintext
39 lines
3.1 KiB
Plaintext
452 Part IV: Additional Considerations
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the fundamentals of the company, it is expected that the remaining stock will sell for
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approximately $40 per share. Thus, the average share of XYZ is worth 55 if the ten
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der offer is completed ( one-half can be sold at 70, and the other half will be worth
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40). XYZ stock might sell for $52 or $53 per share until the tender is completed. On
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the day after the tender offer expires, XYZ stock will drop immediately to the $40 per
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share level.
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There are two ways to make money in this situation. One is to buy XYZ at the
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current price, say 52, and tender it. The remaining portion would be sold at the lower
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price, say 40, when XYZ reopened after the tender expired. This method would yield
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a profit of $3 per share if exactly 50% of the shares are accepted at 70 in the tender
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offer. In reality, a slightly higher percentage of shares is usually accepted, because a
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few people make mistakes and don't tender. Thus, one's average net price tnight be
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$56 per share, for a $4 profit from this method. The risk in this situation is that XYZ
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opens substantially below 40 after the tender at 70 is completed.
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Theoretically, the other way to trade this tender off er might be to sell XYZ short
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at 52 and cover it at 40 when it reopens after the tender offer expires. Unfortunately,
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this method cannot be effected because there will not be any XYZ stock to borrow in
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order to sell it short. All owners will tender the stock rather than loan it to arbi
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trageurs. Arbitrageurs understand this, and they also understand the risk they take if
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they try to short stock at the last minute: They might be forced to buy back the stock
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for cash, or they may be forced to give the equivalent of $70 per share for half the
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stock to the person who bought the stock from them. For some reason, many indi
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vidual investors believe that they can "get away" with this strategy. They short stock,
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figuring that their brokerage firm will find some way to borrow it for them.
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Unfortunately, this usually costs the customer a lot of money.
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The use of calls does not provide a more viable way of attempting to capitalize
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on the drop of XYZ from 52 to 40. In-the-money call options on XYZ will normally
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be selling at parity just before the tender offer expires. If one sells the call as a sub
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stitute for the short sale, he will probably receive an assignment notice on the day
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after the tender offer expires, and therefore find himself with the same problems the
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short seller has.
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The only safe way to play for this drop is to buy puts on XYZ. These puts will be
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very expensive. In fact, with XY"L at 52 before the tender offer expires, if the con
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sensus opinion is that XYZ will trade at 40 after the offer expires, then puts with a 50
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strike will sell for at least $10. This large price reflects the expected drop in price of
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XYZ. Thus, it is not beneficial to buy these puts as downside speculation unless one
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expects the stock to drop farther than to the $40 level. There is, however, an oppor
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tunity for arbitrage by buying XYZ stock and also buying the expensive puts. |