This was originally published on RealMoney. It is being republished as a bonus for TheStreet.com readers.
In this week's Options Mailbag, we tackle questions regarding merger activity, and the names given to certain positions.
With the recent spate of merger activity, readers have been asking whether options can be used to profit from the price spreads between the
bid and the current price.
An example is the announcement that
Dow Chemical (DOW Quote - Cramer on DOW - Stock Picks) will paying $78 share, or $15 billion in cash, for
Rohm and Hass(ROH Quote - Cramer on ROH - Stock Picks). One reader asked the following question.
Steve,
First, you should get big royalties for looking like the thug in "Grand Theft Auto." That's a good thing! Option question that is buggin' me: So ROH gets a market top bid and goes up like crazy. Now, what would be wrong with buying ROH stock after the pop and selling 10
covered calls for July?
Thanks, JJ
Hey JJ, I'm going take that thug comment at face value. I swear I've never presented a trade to buy some
calls I owned as an offer too good to refuse or imply there would be repercussions. But jokes aside, there is nothing to be gained by trying to establish a covered call, or almost any other option position.
Right now, ROH is trading around $74 a share. Assuming the $78 takeover value is achieved, that leaves $4 of upside.
The July 75 calls are trading just 10 cents today [Jul. 18]. So, if you sold those, you would be capping your profit to just $1.10.
All other calls over the $75
strike, which are structured in $5 increments, have no value, as it is assumed the stock will not go above $78.
Calls that are
in-the-money are only trading at their intrinsic value. For example, for the $60 call across all
expirations, there is no premium to collect; they all are valued at about $14 a contract.
As a friendly all-cash deal that should close in a relatively short time period, there is little, let's call it nothing, that can be done to boost gains by writing a covered call.
On the more complex deals in which stock, debt or
dividends are involved, there are arbitrage situations available. An example of this would be the Inbev purchase of
Anheuser-Busch (BUD Quote - Cramer on BUD - Stock Picks) for $70 a share. BUD is currently trading around $67 a share, meaning there is theoretically $3 of profit remaining in the stock.
Steven Smith
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