In the rush to cash in on competing offers for Conoco Inc., investors sold thousands of shares of Conoco stock they didn't own, causing disruptions in the stock and options markets that required unprecedented remedies.
The fight for Conoco ended Aug. 5 after E.I. du Pont de Nemours & Co. offered more than $7 billion for Conoco, but the fallout from the most costly corporate takeover battle in history did not hit until this week.
Yesterday many investors who held options to buy Conoco stock learned that they will not be able to get their shares as the result of an extrordinary decision made Tuesday by the Options Clearing Corp. of Chicago.
The OCC is a private corporation that settles most option transactions for the exchanges by collecting the shares from option sellers and delivering them to investors who exercise options to buy shares.
The clearing house decided Tuesday to shortcut the usual proceedure because it could not get enough Conoco shares to deliver to investors who asked for them, said Mark Berman, senior vice president and general counsel of the OCC.
Instead of the stock, investors who exercised their Conoco options will get $92 a share -- the same amount they would have received if they had gotten the stock and had been able to sell it to Seagram Co., which was bidding against Du Pont and Mobil Corp. for Conoco.
The $92 a share in cash will be paid to persons who asked for delivery of Conoco options before Aug. 7, the final day to accept the Seagram offer, Berman said.
This was the first time since the clearing corporation was set up in 1973 that it has had to step in and order a cash settlement, he added. "It's unusual for us," Berman said. "It's also unusual to have a three-way takeover fight."
The decision affects investors who asked for delivery of about 2 million shares of Conoco before Aug. 7. By that time virtually all the Conoco stock had already been bought by Seagram, Mobil or Du Pont, so there was little stock left on the market. The buyers will not lose any money as a result of the decision, but the sellers could save large amounts.
Berman said the unprecedented action by the clearing house was meant "to avoid the adverse effect of a short squeeze," a situation similar to cornering the market in Conoco options.
Had the OCC not stepped in, persons who promised to deliver Conoco stock would have been forced to do so -- at any price. They could have been forced to buy the stock for $98 or $100 or more just so they could meet their obligation to sell it for $92.
Yesterday's trading in Conoco shares indicated that some of that desperation buying still is going on, said Howard Brenner, who follows trading in Conoco options for Drexel Burnham Lambert.
Du Pont won the fight for Conoco by offering to trade 1.7 shares of its stock for each share of Conoco; therefore, each share of Conoco ought to be worth 1.7 times as much as a share of Du Pont.
At yesterday's prices, 1.7 shares of Du Pont could be purchased for about $75, but Conoco shares were quoted at $83.
Berman said the OCC decided to settle options transactions in cash to avoid disrupting the market in Conoco shares.
Stock option transactions frequently are settled in cash anyway. Many Conoco options investors decided to exercise their options and take delivery of the stock because they apparently felt there was a better chance to make money on the Conoco deal by having the shares.
An investor who buys a stock option obtains the right to buy 100 shares of the stock at a fixed price; an option seller gets the right to sell shares at a fixed price at a certain date. If the price of the shares goes up, the seller loses money -- by gettting less than the market price for the shares -- and the buyer profits.
Market analysts said the short squeeze in Conoco developed because investors sold stock or options on stock that they did not own, or agreed to sell stock to Seagram although they already had sold an option for that stock to someone else.
Here's how an investor could get "squeezed" in the Conoco options trading:
Someone who owned Conoco stock saw the price going up as Du Pont, Seagram and Mobil began trying to buy the company. Instead of selling the stock, the holder tried to lock in a profit by selling an option on the shares.
When Seagram bid $87 a share for Conoco, the stockholder accepted the tender offer and sent in the shares, figuring the profit from the sale to Conoco would more than offset the loss on the options sold. The investor who bought the option would be entitled to the difference between the option price and whatever the stock was selling for when the option expired.
Instead of settling for the cash, however, some options buyers demanded the stock, apparently hoping it would continue to increase in value.