Corporate events affect the price of various financial and investment assets. These events might include mergers and acquisitions, financial report announcements, bad public relations events, and other major developments, and they can impact the prices of stocks and options. This article will examine how these events affect options prices and how traders can capitalize on the resulting price movements.
Understanding Corporate Events
A corporate event is any meeting, gathering, or activity organized by a business to achieve specific objectives. These events can take various forms. They typically serve specific purposes, and can be geared toward employees or stakeholders, or used for announcing something regarding the company.
Some of the corporate events that can affect options prices include:
- Earnings reports
- Mergers and acquisitions
- Stock splits and dividends
- Product announcements and launches
- Regulatory actions and other legal issues
- Share buybacks
Earning Reports and Options Volatility
Options are contracts to buy or sell an underlying asset at a given price or before an agreed-upon date. Many factors can impact the price of a contract’s options, one being volatility, a measure of the risk or uncertainty associated with that option’s underlying asset’s price movements.
Earning reports can change the market sentiment and the desirability of a company’s stocks, leading to fluctuations in the underlying asset’s price and, thus, its volatility. Traders and investors already anticipate price swings before earning calls.
As a result, they ask for higher premiums for options contracts, thereby causing implied volatility to rise. The implied volatility increases as the market considers the likely price swings that might occur after the earnings report is released.
Another reason for price volatility is traders and investors using the straddle technique. This trading technique entails buying both calls and put options with the same strike price and expiry date. This strategy is highly profitable if the earnings report causes an underlying asset’s price to swing rapidly and is another cause of implied volatility.
There are many other strategies that traders can learn to leverage these price swings, and they are all included in James Cordier’s complete guide to option selling, an option selling handbook that will help them get the most out of options trading.
Mergers and Acquisitions (M&A) and How They Impact Options
Mergers and acquisitions affect the companies involved in the deal and those in related industries. The impact will depend on the merger’s specific terms, the individual companies’ stock prices, and the timeline of the merger or acquisition.
Mergers and acquisitions cause stock price movements by increasing or decreasing the value of the companies involved. These movements affect all assets, trades, and commodities tied to the affected stock prices. The affected investment vehicles that can be affected include exchange-traded funds, mutual funds, and options.
Mergers and acquisitions also often open up speculative markets. Traders can take put and call positions in the financial market as they anticipate the price movements of the underlying stock. Traders who want to profit from movements in either way can use the straddle technique discussed above.
Replacement can also impact options prices. Replacement happens after a successful merger where options for the acquired company are converted into options for the merging company. The replacement can cause stock prices and option values to fluctuate depending on how the replacement goes and whether people enter or exit options contracts after the successful merger.
Lastly, mergers and acquisitions can affect options when they are delisted, or cash settled. Both can happen when options placed on the acquired company cease to exist after the successful merger. When this happens, traders who had bought options on the acquired company’s stock can receive cash replacements and have their options delisted.
Dividends and Option Prices
Some companies pay dividends on the shares individuals hold. For example, they may pay $1 per share monthly, quarterly, bi-annually, or annually depending on the agreed terms. Dividends are an excellent source of passive income for many investors who want a regular income with the option of selling their stocks at any time, thereby benefiting from their liquidity.
How much dividend a company pays often reflects how well the company is doing. For example, companies growing very fast, have large cash flows, or make huge profits are more likely to pay higher dividends. If, for any reason, they reduce their dividend payouts, things can change rapidly for them in the market. People can speculate that the company is not doing as well as they thought.
The opposite can also happen if the company pays higher dividends than in the past.
Because dividend payments impact the market so significantly, they can cause significant movements in the options market. Those with a negative outlook on the company due to its dividend payout can buy put options, expecting to profit when the share price falls. Those with an optimistic outlook can buy call options to profit when the share price increases.
Those who want to take both sides and benefit from price fluctuations either way can invest on both sides.
Volatility Crush Can Lead to Losses
Once the volatility caused by the corporate event passes, the share price will likely settle where it was before the event. This leads to reducing implied volatility, also known as the post-event volatility crash.
Crashing volatility can lead to losses for investors who had entered put and call positions and for whom the final stock price did not end up where they wanted. These investors can lose their premium or suffer huge losses if they end up with assets they wished to sell at a profit but are worthless once everything settles following the event or announcement.
Businesses and organizations understand that any corporate events or announcements can introduce uncertainty that causes volatility. Such volatility affects share prices and all other assets tied to it, including different funds, indexes, and options. Traders and organizations must, therefore, prepare for uncertainty and eventualities following corporate events to minimize their downside once everything settles.
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