42 lines
2.2 KiB
Plaintext
42 lines
2.2 KiB
Plaintext
Chapter 27: Arbitrage 453
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Before giving an example of that arbitrage, a word about short tendering is in
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order. Short tendering is against the law. It comes about when one tenders stock into
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a tender offer when he does not really own that stock. There are complex definitions
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regarding what constitutes ownership of stock during a tender offer. One must be net
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long all the stock that he tenders on the day the tender offer expires. Thus, he can
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not tender the stock on the day before the offer expires, and then short the stock on
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the next day ( even if he could borrow the stock). In addition, one must subtract the
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number of shares covered by certain calls written against his position: Any calls with
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a strike price less than the tender off er price must be subtracted. Thus, if he is long
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1,000 shares and has written 10 in-the-money calls, he cannot tender any shares. The
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novice and experienced investor alike must be aware of these definitions and should
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not violate the short tender rules.
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Let us now look at an arbitrage consisting of buying stock and buying the expen
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sive puts.
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Example: XYZ is at 52. As before, there is a tender offer for half the stock at 70, with
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no plans for the remainder. The July 55 puts sell for 15, and the July 50 puts sell for
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10. It is common that both puts would be predicting the same price in the after-mar
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ket: 40.
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If one buys 200 shares ofXYZ at 52 and buys one July 50 put at 10, he has a locked
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in profit as long as the tender offer is completed. He only buys one put because he
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is assuming that 100 shares will be accepted by the company and only 100 shares will
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be returned to him. Once the 100 shares have been returned, he can exercise the put
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to close out his position.
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The following table summarizes these results:
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Initial purchase
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Buy 200 XYZ at 52
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Buy 1 July 50 put at 10
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Total Cost
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Closing sale
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Sell 1 00 XYZ at 70 via tender
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Sell 1 00 XYZ at 50 via put exercise
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Total proceeds
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Total profit: $600
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$10,400 debit
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1,000 debit
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$11 ,400 debit
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7,000 credit
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5,000 credit
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$12,000 credit
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This strategy eliminates the risk ofloss ifXYZ opens substantially below 40 after
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the tender offer. The downside price is locked in by the puts. |