Two option contracts giving two companies the right, but not the obligation, to buy a significant amount of stock in each other for a certain strike price. Cross options are most common when the companies are in the process of merging anyway. The companies enter the cross option in order to reduce the risk that a third party will come and disrupt the merger by buying one of the companies.
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An option that permits each of two parties to purchase a specified ownership stake in the other. For example, a cross option may allow each of two companies to buy 10% ownership in the other company. Cross options are frequently used in merger agreements in order to thwart hostile takeover bids from a third party.
Case Study In April 2001 First Union Corporation and Wachovia Corporation, two large commercial banking firms, announced a merger agreement under which First Union would acquire Wachovia in an exchange of stock. The price offered by First Union for Wachovia was at a relatively small premium to the premerger price, and some analysts and investors believed another bidder might emerge to make a better offer. Wachovia had previously engaged in merger discussions with SunTrust Banks, which many analysts believed was a better fit with Wachovia. To thwart another bidder, the two banks used a cross option that allowed either bank to purchase a 19.9% stake in the other. The cross option allowed First Union to purchase nearly 20% of Wachovia so that a hostile bidder would have to negotiate with First Union for a large amount of Wachovia stock. In the less likely case of a hostile offer for First Union, the bidder would be required to negotiate with Wachovia to buy a large block of First Union stock. Thus, the cross option served as a deterrent to another company interfering in the planned merger.
Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.