Bankruptcy is a risk for GM and F option traders
Wednesday, 19 November 2008 14:17
The automakers, Ford and GM continued their appeal to law makers and the American public for bailout funds today. I have senior democrats in the US Senate were beginning to down play the possibility for a rescue happening before recess. This situation raises an interesting question for very speculative traders. bankruptcy

There is a lot of talk right now about taking some long bets on some of these near-bankrupt stocks. The potential for upside is appealing. After all, how much farther can they go down? But what happens to a stock or option when a company goes into bankruptcy?

If the company goes into liquidation (one of the potential results of the bankruptcy process) all its assets will be gone before common shareholders or option holders get any money. However, if the company reorganizes within bankruptcy shareholders may still be able to walk away with some value at the end of the process while option traders are likely to get nothing.

When a company seeks bankruptcy protection, trading in its stock is typically halted. The liquid market for its shares dries up and option buyers may be left holding a worthless asset. If there is no market for the stock and expiration day passes, the option will expire worthless. Option writers, on the other hand, could walk away with the entire premium. In the video I will cover what happens to an option when trading is halted.

The real take-away from this article is not that aggressive traders should not be buying and selling these stocks and options on those stocks but that they need to appreciate the risks associated with a company on the verge of bankruptcy. These risks are not isolated to just whether the company can emerge from bankruptcy. The risk of an illiquid market forcing all its options to expire worthless must also be accounted for.

In the article I refer to a document called Characteristics and Risks of Standardized Options published by the Options Clearing Corporation. You can get a copy of that document for yourself here.  

Learning Markets Video Click here to see the video on stock options and bankruptcy.

Learning Markets offers daily articles, videos and investing guides—for free—about everything from investing in stocks and options to trading currencies in the forex market and more. VisitLearningMarkets.com to learn more about investing and to interact with other investors just like you.

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3.25 Copyright (C) 2007 Alain Georgette / Copyright (C) 2006 Frantisek Hliva. All rights reserved."