Petrobakken manipulation: who is going to pay the fine this time SEC?

A few months ago I wrote a post critical of the hardline that the SEC took against Jonathan Lebed for so-called “pump & dump”.  Lebed was a 15 years old at the time, and he was promoting penny stocks that he liked using bulletin boards and the like.  It turned into a pretty lucrative trade for him, but the SEC made him pay a huge fine.  I said that it was not right for them to go after some kid, when the people on Wall Street do this sort of thing all the time.  Today, I think I found an example with one of the securities that I trade, Petrobakken.

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Petrobank spinoff II: What happens to an option contract?

In a previous post, I wondered what happens to an options contract after a spinoff. Petrobank spun off Petrominerales–its Columbian holdings.  I figured, based on the rules, that if my puts were assigned I would receive 100 shares of Petrobank and 61.5 shares of Petrominerales, and then learned that the Montreal Stock Exchange confirmed my analysis.

Saturday the January contract expired.  PBG closed at $23.38 and PMG at $37.27; thus the closing price for the underlying  = 23.38 +37.27*0.615=$46.30.  Well, a newbie in the backroom of the options desk at my brokerage decided my January $42 was in the money and exercised my contracts, charging me the $42 per share of Petrobank plus a $43 commission.   Obviously, Petrobank at $23.38 was deep in the money, right?  $23.38 is a lot less than $42.00.   This is the note in my activity (with amounts whited out):

Apparently, not everyone in the backroom knows what she’s doing and somebody a little smarter decided that this assignment better be canceled.  I never did get my 61.5 shares of Petrominerales (per contract). But hey, guys, if you want to assign me 100 shares of PBG and 61.5 shares of PMG, I’d happily receive them for the price of 100 shares at $42.  That would be a net gain of $4.30 per share.  I’ve heard that once in a blue moon a novice options buyer will exercise an out of the money option–for the seller, this is a gift.

My final thoughts on this is that after a bit of experience, it is very possible that the DIY trader will know more about options than some of the people working the options desk at the brokerage.  When I first started out, I asked about the commission rates upon assignment/exercise–not just once but several times.  Each representative gave me a different answer: one said standard commission, others said they didn’t have any idea, others said $43–but what about multiple contracts?  No idea.  etc. etc. etc.  I finally stopped trying to get a definitive answer and just waited.  My contracts that did expire in the money were charged $43 (the DIY rate) upon assignment and this was for multiple (5) contracts in the same order.  So the actual event helped me to formulate a better cost analysis.

Petrobank spinoff: what happens to an option contract? (updated)

Update 29 December 2010:  Please note that Montreal Stock Exchanged has clarified these issues in a PDF document:  the contracts are now trading under the ticker PBG1.  The value of each contract is essentially what I predicted in this post.  Each contract is now based upon the following:

100 common shares of Petrobank (PBG) and 61 common shares of New Petrominerales (PMG) and a cash portion equivalent to 0.5 common share of PMG


Original post:

I have sold some April puts on Petrobank.  Yesterday they announced the spinoff of their holdings in Petrominerales of which they own 60%.  According to the Globe and Mail, Petrobank holders will receive shares Petrominerales when the arrangement closes before December 31:

The subsidiary, which produces oil in Colombia, saw its shares climb by almost 7 per cent. Following the reorganization, Petrobank shareholders will receive approximately 0.62 shares of the former subsidiary, renamed New Petrominerales, for every share of Petrobank they currently own.

I’ve sold some put contracts of Petrobank, and I was wondering what happens to my options contracts in case they are in the money at expiration, since the new share price of Petrobank will obviously adjust to reflect its value after the spinoff.  I found this answer at the International Securities Commission:

Corporate actions such as mergers, acquisitions and spinoffs will often necessitate a change to the amount or name of security that is deliverable under the terms of the contract. When such adjustments occur, the short call position is responsible for delivering the adjusted security.

For example: The shareholders of company JKL Inc. have approved a takeover bid placed by Global Giant Co. As a result, holders of JKL stock will now be entitled to a 1/2 share of Global Giant for every share of JKL Inc. they own. Therefore, holders of JKL call options will now be entitled to a deliverable amount of 50 shares of Global Giant for every contract of JKL that they are long (100 shares per contract x .5 Global Giant). Investors with short positions in JKL call options would then be responsible for delivering 50 shares of Global Giant for every call option assigned.

If I am correct, if my shares are assigned, I will receive at the strike 100 shares of Petrobank for each April contract in the money; I would also receive 62 shares of New Petrominerales.  Those exercising a call contract would receive the same.  I don’t know how the  price would be calculated, but I assume the combined market price on expiry of 100 shares of Petrobank and of 62 shares of Petrominerales.  If anyone knows, please make a comment below.