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