Dealing with Deals, and What They Mean for Options

This week's forum explores tender offerings and pricing disparities.
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Even the most savvy options traders run into problems when analyzing prices or trying to figure out situations unique to a particular stock at a particular time.

While the terms of deals may be relatively simple, they often have an impact on options pricing and value. We deal with a couple of those situations in this week's Options Forum. The best advice the pros give is to let the fundamentals rule and not to try to outsmart the market or yourself by wrapping up a position with hard-to-swallow options plays.

Enjoy the holiday weekend and keep your questions (and your full names) coming to the

Options Forum.

Tender Mercy

I was wondering if you could help explain an options question for me. A company called Building One (BOSS) - Get Report is doing a tender for 55% of its shares at 22.50. The recap also calls for an investment of $100 million from an investor, who in turn will get 4.4 million shares in the company (a deal should close April 16). The question I have relates to the options in the company. Why would the May 12.5 and the August 12.5 call options be trading for the same price (5 at the time of this letter)? Is the buyback treated as divided? I think the stock after the tender should trade at least at the investor buy-in price, 100/4.4=22.5. Darren Holstein


In this case, you're treading in some very dangerous waters.

Just because the tender for 55% of the shares has been announced, it doesn't mean that everyone who attempts to tender shares will be satisfied. You could tender 40,000 shares and only be able to sell 20,000.

With that in mind, you have to be aware that people will try to game the situation to play for the day after the tender. Often, traders will sell one call that expires after the tender date and buy another for the shorter term.

When those who tendered shares unsuccessfully try to sell their shares in the open market, they can benefit from however the stock moves in response.

We talked to a few pros who advised sticking to whatever your fundamental belief is in the stock and not opening yourself up to more problems by trying to match up an options strategy. There's little you can do that the professionals haven't figured out.

LEAPS Pricing

Is there a method for determining if the price of a LEAP call is a good price? Merck's (MRK) - Get Report January 85s closed recently at 8. That doesn't seem like a bad price, but of course, the market doesn't look good now, and may continue for some time like this. Also, I noticed that Merck's LEAPS do not trade as high as Cisco (CSCO) - Get Report LEAPS. I guess examining the prices of these LEAPS can give an investor some insight into where the market thinks the price of a particular stock may be trading, based on today's information. Scott Geiger


The prices of LEAPS options, which expire in January 2000 and 2001, are always going to be higher than the prices of standard options (which expire monthly). That's because the time premium portion of their price is higher than on options that have less time until the expire.

Time premium is just one component of options pricing. Another key factor is implied volatility, and that will help explain why Merck LEAPS don't cost as much as similar Cisco LEAPS.

As a tech stock, Cisco resides in a volatile sector, so it's more likely to move quickly in either direction than Merck, which is a stable pharmaceutical company. Cisco's historical volatility over the past 50 days, for instance, is 50 while Merck's is 31. Cisco's current implied volatility, according to

McMillan Analysis, is 41, while Merck's is just 30.

But volatility is one thing that can make a difference between similar options on different companies.

One of our friends at a major firm says the theoretical value of the option you mentioned is 8.05, pretty close to where the thing is trading. There are services, such as

MyTrack from

Track Data

or the

Options Toolbox, that can give you the value of any option.

But you need to be sure not to simply trade based on the theoretical value. You have to also have in your mind the delta of the option (or how much the stock has to move for the option's price to increase $1) and the break-even. In your case, for you to break even, Merck has to hit 93, which would be outside its 52-week northern boundary of 87 3/8.

So, in this case, even though the Merck options cost less than the Cisco options, and the theoretical value is close to the price, the option is somewhat expensive.

Covered-Call Calculation

I own 1,000 Knight/Trimark (NITE) at 40. I recently wrote 6 October 55 calls at 16. Are these assumptions correct? Knight/Trimark closed at 67 on March 31. Lee Kramer

If the stock rises and is called away, I have effectively sold 600 shares at 71 (55 strike + 16 premium). But I can participate in any upward move with the 400 shares I still own?

If the stock should decline, and close below 55 at the October expiration, my cost basis for the 600 shares I've written calls against is now 24 (40-16).

At 39, I have lost the covered-call premium (55-16).


The feeling here is that you did a nice job on this one.

You sold a call on a volatile stock that was further out on the expiration calendar. That gives you a nice juicy chunk of premium and enough of an upside from where you bought the stock to do well on both ends of the trade.

The implied volatility on Knight/Trimark has been in the 80 range lately, so with the potential for a roller coaster ride comes that big premium. Another wise move was not covering your entire position. That way, if the stock does rally, you can let some of your options get assigned and still participate somewhat in the upside.

As far as your calculations, you're on the mark on each but the last one. You lose the premium not at 39 but at 24 because your basis on that is the 40 you paid, not the 55 strike price, according to Scott Fullman of

Swiss American Securities



With the new AMEX "QQQ" product, I've heard that there will be options on these also. Where does this leave the original NDX options? Are these the same, or is there a difference I should know about? Tom Wang


The major difference between the NDX options, which trade on the

Chicago Board Options Exchange

, and the QQQ options, which trade on the

American Stock Exchange

, is that the NDX is a cash-settled contract and the QQQ is not.

When you exercise a QQQ option, you get access to an underlying security, the

Nasdaq 100

unit trust, which also trades on the Amex.

When you exercise an NDX option, the terms of the contract are fulfilled through the payment or receipt of dollars in the amount that the contract is in-the-money.

The other main difference is that the NDX is the province of institutional and professional traders while the QQQ may be somewhat more accessible to individual investors.

TSC Options Forum aims to provide general securities information. Under no circumstances does the information in this column represent a recommendation to buy or sell securities.