Do Stock Options Protect Against Bankruptcy?

Discussion in 'Options' started by Doug125, Jan 1, 2004.

  1. Doug125


    Will a stock put option remain in force in the event that the company corresponding to the underlying stock asset goes bankrupt? Let's say the stock stops trading due to bankruptcy.
  2. options don't have anything to to do with the company itself. they are a contract between two people. if a company goes bankrupt no new options will trade but you still have the right but not the obligation to act against the person on the other side of your existing options.
  3. ktm


    Assuming the option has not expired, then yes it is still in force. Different brokers have different ways of effecting a "cash out" in those circumstances.

    You may end up following the underlying to the pink sheets. You might need to exercise the option (and be given a short position in the underlying from your strike) or the broker may set a price for the underlying (a few cents or sometimes even zero) if it has stopped trading altogether.
  4. jessie


    When you worry about things like default on exchange traded options or futures, it is important to remember that you don't really trade with another individual or company. Technically the exchange clearing house is always a middleman, and acts as the buyer to every seller and the seller to every buyer, and so you have the full resources of the clearing house backing all trades.
  5. You should always try going to the horse's mouth first - i.e., see if the CBOE has any information posted about the subject.

    In this case, the answer isn't as black and white or simple as suggested above.

    The following is from the CBOE's Option Corner:

    If an investor purchases a put, the target company files for bankruptcy, and trading is halted in the underlying common stock, what is the mechanism for settling the position? It seems that if the put is in the money it would retain value, but I'm unclear on the settlement mechanism in such a situation.

    The courts, the SEC, another regulatory agency, The Options Clearing Corporation (OCC) or the options markets may impose exercise restrictions. While an American-style option can normally be exercised at any time prior to its expiration, The OCC and the options markets have authority to restrict the exercise of options at certain times in specified circumstances. The option markets often exercise such authority with respect to an option in which trading has been halted. If a restriction on exercise is imposed at a time when trading in the option has also been halted, holders of that option will be locked into their positions until either the exercise restriction or the trading halt has been lifted.

    Exercise restrictions imposed by The OCC and the options markets affecting cash-settled options generally cannot be continued in effect beyond the opening of business on the last trading day before their expiration. Such exercise restrictions affecting physical delivery options generally cannot be continued beyond the opening of business on the tenth business day before their expiration, but with one important exception. If The OCC determines that the available supply of a security underlying a physical delivery option appears to be insufficient to permit delivery of the security by the writers of all outstanding calls in the event of exercise, or that foreign government restrictions would prevent or unduly burden the orderly settlement of exercises of foreign currency options, The OCC may indefinitely prohibit the exercise of puts by holders who would be unable to deliver the underlying security. The holder of such a put could lose his entire investment in the option if the prohibition remained in effect until the puts' expiration and the holder was unable either to acquire the underlying interest or to sell his put in the market. The put holder might be unable to do either because the very event that caused The OCC to impose the exercise prohibition (e.g., a suspension of trading in an underlying stock) might not only make it difficult or impossible to obtain the underlying interest, but might also impair the market in options on that interest.

    It is also possible that a court, the SEC or another regulatory agency having jurisdiction would impose a restriction that would have the effect of restricting the exercise of an option. In such a case, the option would not be exercisable until the restriction was terminated. In the remote possibility that the restriction were to remain in effect until the expiration of the option-which has never yet occurred-the option would expire worthless, and the holder would lose the entire amount that he paid for the option.
  6. wow i never knew they had that ability. i wonder if it has ever happened?
  7. nitro


    That is why you would "never" buy a put to play the downside on _equities_ (this does not affect things like commodities that can never trade at zero.) Instead, you would buy the synthetic put, short stock long call, with the call having the desired moneyness and extrinsic value.

  8. Doug125


    Thanks for all the comments. This is very helpful.