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Sears Headache


I commented briefly on K-Mart (KMRT) options and that once the deal settles at the end of March, those options will not change.

It is much more difficult for the Sears (S) options.

If you own S shares, into the deal you must elect which you want, either as much KMRT stock as possible or as much cash as possible. The choice depends on where KMRT stock is at the time. If everyone just owned stock, the ending ratio would be 45% in $50 cash plus 55% in half a share of KMRT. The problem arises if you fall asleep and don't elect, you get the scraps: the portion that no one wants.

Let's say there are 100 shareholders and KMRT is at $100, which as you will see is the level of indifference. If 99 shareholders elect for as much stock as possible, but one shareholder does not elect, the 99 shareholders will get 44% in cash and 56% in stock for a value of ((.44 x 50) + (.56 x .5 x 100)) = $50. The sleepy shareholder will get 100% of $50 = $50. Since the value is the same, $100 stock price for KMRT becomes the threshold.

With KMRT at $120, the sharp shareholders will certainly elect for as much stock as possible and will receive $55.60 ((.44 x 50) + (.56 x .5 x 120)) in value and the dull shareholder will receive the same $50.

If KMRT is trading at $80, the sharp shareholders will elect for as much cash as possible and will receive ((.46 x 50) + (.54 x .5 x 80)) = $ 44.60. The dull shareholder will receive $80 x .5 = $40.

So don't fall asleep.

S option holders don't own the stock before they exercise, so they must carefully analyze the situation to determine whether or not they should exercise and then elect. Like our sleepy shareholder, if they do not exercise with KMRT stock over $100, they will only receive $50 in value. If you notice, the puts in S are trading parity to a stock price of only $50 even though the stock price is actually trading around $56. This is because you can buy the stock at $56 and elect to receive that much in value and then buy a 55 strike put and only be responsible for $50 in value. Any arbitrager (me) would gladly pay $4 for that put and lock in $1 in free money.

This is a strange deal indeed. I highly advise anyone with S options to study the above and apply it to your individual position.

Don't fall asleep.
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Position in S

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