We previously discussed stock splits and stock dividends. You learned why companies use them and how they affect stock positions. When a stock split or stock dividend occurs, option contracts on that stock are also adjusted.
A forward stock split increases the number of shares outstanding and lowers the price per share. Start with this option position:
Long 1 ABC Jan $200 call (right to buy 100 shares @ $200)
When a forward stock split occurs, the contract is adjusted based on the split type. There are two types of forward splits: even and uneven.
An even stock split is easy to spot: if the split ratio ends in 1, it’s even. For example:
With even stock splits, the option adjustment changes:
But the shares delivered at exercise (per contract) stays the same.
Assume this position again:
Long 1 ABC Jan $200 call (right to buy 100 shares @ $200)
What would the contract become if ABC stock was subject to a 2:1 stock split?
Answer: Long 2 ABC Jan $100 calls
To calculate the adjustment, use the stock split factor we learned previously.
First, find the factor:
Next, adjust the number of contracts:
Last, adjust the strike price:
So the investor goes from 1 long $200 call to 2 long $100 calls.
Let’s see if you can make the same adjustments. Again, assume this position:
Long 1 ABC Jan $200 call (right to buy 100 shares @ $200)
What would the contract become if ABC stock was subject to a 5:1 stock split?
Answer: Long 5 ABC Jan $40 calls
To calculate the adjustment, use the stock split factor.
First, find the factor:
Next, adjust the number of contracts:
Last, adjust the strike price:
So the investor goes from 1 long $200 call to 5 long $40 calls.
An uneven stock split uses a ratio that does not end in 1. For example:
With uneven stock splits, the option adjustment changes:
But the number of contracts stays the same.
Assume this new position:
Short 1 XYZ Sep $90 put (obligation to buy 100 shares @ $90)
What would the contract become if XYZ stock was subject to a 3:2 stock split?
Answer: Short 1 XYZ Sep $60 put (covering 150 shares)
We’ll use the stock split factor to calculate the adjustment.
First, find the factor:
Next, adjust the strike price:
Last, adjust the shares delivered at exercise:
So the investor goes from an obligation to buy 100 shares at $90 to an obligation to buy 150 shares at $60.
Let’s see if you can adjust for an uneven split. Again, assume this position:
Short 1 XYZ Sep $90 put (obligation to buy 100 shares @ $90)
What will the option contract become if a 5:4 stock split occurs on XYZ stock?
Answer = Short 1 XYZ Sep $72 put (covering 125 shares)
We’ll use the stock split factor to calculate the adjustment.
First, find the factor:
Next, adjust the strike price:
Last, adjust the shares delivered at exercise:
So the investor goes from an obligation to buy 100 shares at $90 to an obligation to buy 125 shares at $72.
A reverse stock split reduces the number of shares outstanding and raises the price per share. Option contract adjustments are handled the same way as uneven forward splits.
Assume this new position:
Long 1 MNO Dec $10 put (right to sell 100 shares @ $10)
What would the contract become if MNO stock was subject to a 1:4 reverse stock split?
Answer: Long 1 MNO Dec $40 put (covering 25 shares)
We’ll use the stock split factor to calculate the adjustment.
First, find the factor:
Next, adjust the strike price:
Last, adjust the shares delivered at exercise:
So the investor goes from a right to sell 100 shares at $10 to a right to sell 25 shares at $40.
Let’s see if you can adjust for a reverse split. Again, assume this position:
Long 1 MNO Dec $10 put (right to sell 100 shares @ $10)
What would the contract become if MNO stock was subject to a 1:20 reverse stock split?
Answer: Long 1 MNO Dec $200 put (covering 5 shares)
We’ll use the stock split factor to calculate the adjustment.
First, find the factor:
Next, adjust the strike price:
Last, adjust the shares delivered at exercise:
So the investor goes from a right to sell 100 shares at $10 to a right to sell 5 shares at $200.
Stock dividend contract adjustments use the same process as uneven forward splits and reverse splits. Stock dividends are quoted as a percentage, for example:
Assume this new position:
Short 1 ZZZ Apr $55 call (obligation to sell 100 shares @ $55)
What would the contract become if ZZZ stock was subject to a 10% stock dividend?
Answer: Short 1 ZZZ Apr $50 call (covering 110 shares)
First, determine the stock dividend factor:
Next, adjust the strike price:
Last, adjust the shares delivered at exercise:
So the investor goes from an obligation to sell 100 shares at $55 to an obligation to sell 110 shares at $50.
Let’s see if you can adjust for a stock dividend. Again, assume this position:
Short 1 ZZZ Apr $55 call (obligation to sell 100 shares @ $55)
What would the contract become if ZZZ stock was subject to a 25% stock dividend?
Answer = Short 1 ZZZ Apr $44 call (covering 125 shares)
We’ll use the stock dividend factor to calculate the adjustment.
First, find the factor:
Next, adjust the strike price:
Last, adjust the shares delivered at exercise:
So the investor goes from an obligation to sell 100 shares at $55 to an obligation to sell 125 shares at $44.
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