When a stock splits, call and put options are adjusted accordingly. In almost every case the Options Clearing Corporation (OCC) has provided rules and procedures so options investors are “made whole” when stocks split. This makes sense since the OCC wishes to maintain a relatively stable and dependable market in options, not a market in which options holders are left holding the bag every time that a company decides to split, spin off parts of itself, or go private.
In general, stock dividends of greater than 10% are called stock splits and result in options splits or adjustments. For example, a 100% stock dividend is the same as a 2-for-1 split. Stock dividends of 10% or less do not result in any options adjustments. Just to be clear about the notation used here, a split of 2:1 or 2-for-1 means for every 1 share before the split, after the split the holder has 2. Similarly, a reverse split of 1 for 4 or 1:4 means for every 4 pre-split shares, the holder has just 1 after the split.
What Happens When a Stock Option Splits?
A stock split may involve a simple, integral split such as 2:1 or 3:1, it may entail a slightly more complex (non-integral) split such as 3:2, or it may be a reverse split such as 1:4. When it is an integral split, the option splits the same way, and likewise the strike price. All other splits usually result in an “adjustment” to the option.
The difference between a split and an adjusted option, depends on whether the stock splits an integral number of times — say 2 for 1, in which case you get twice as many of those options for half the strike price. But if XYZ company splits 3 for 2, your XYZ 60s will be adjusted so they cover 150 shares at 40.
It’s worth reading the article in this FAQ on stock splits, which explains that the owner of record on close of business of the record date will get the split shares, and — and — that anyone purchasing at the pre-split price between that time and the actual split buys or sells shares with a “due bill” attached.
Stock Option Split Example
Now what about the options trader during this interval? He or she does have to be slightly cautious, and know if he is buying options on the pre-split or the post-split version; the options symbol is immediately changed once the split is announced. The options trader and the options broker need to be aware of the old and the new symbol for the option, and know which they are about to trade. In almost every case I have ever seen, when you look at the price of the option it is very obvious if you are looking at options for the pre- or post-split shares.
Now it’s time for some examples.
- Example: XYZ Splits 2:1
The XYZ March 60 call splits so the holder now holds 2 March 30 calls. - Example: XYZ Splits 3:2
The XYZ March 60 call is adjusted so that the holder now holds one March $40 call covering 150 shares of XYZ. (The call symbol is adjusted as well.) - Example: ABC declares a 1:5 reverse split
The ABC March 10 call is adjusted so the holder now holds one ABC March 50 call covering 20 shares. - Example: Company PQRS declares a 5% stock dividend
As mentioned above, small stock dividends do not result in any options adjustments.
Spin-offs and buy-outs are handled similarly:
- Example: WXY spins off 1 share of QXR for every share of WXY held.
Immediately after the spinoff, new WXY trades for 60 and QXR trades for $40. The old WXY March 100 call is adjusted so the holder now holds one call for 100 sh WXY @ 60 plus 100 sh WXY at 40. - Example: XYZ is bought out by a company for $75 in cash, to holders of record as of March 3.
Holders of XYZ 70 call options will have their option adjusted to require delivery of $75 in cash, payment to be made on the distribution date of the $75 to stockholders.
Note: Short holders of the call options find themselves in the same unenviable position that short sellers of the stock do. In this sense, the options clearing corporation’s rules place the options holders in a similar risk position, modulo the leverage of options, that is shared by shareholders.
The Options Clearing Corporation’s Adjustment Panel has authority to deviate from these guidelines and to rule on unusual events. More information concerning options is available from the Options Clearing Corporation (800-OPTIONS) and may be available from your broker in a pamphlet “Characteristics and Risks of Standardized Options.”
Article Credits:
Contributed-By: Art Kamlet