Whenever any beginner, start options trading as an options trader ask about “What happens to options in case of a stock split?” It is because the stock splits happens so often and sudden that it throws novice options traders in a state of confusion which further lead to wrong decisions. This state of confusion is not just limited to the beginner options traders but common in equity investors of the share market who are new in the equity market. We’ve seen companies going for stock splits where companies use this corporate action to divide its existing shares into multiple shares. While splitting shares up into multiple shares, the market capitalization remains same.
Most investors and traders are familiar with stock splits of company’s shares. But, what happens when you are holding options instead?
More precisely, “what would happen to an options contract when the underlying stock splits?”
To get to the bottom of it, we will discuss the two scenarios:
- Before Split Announcement
- After Split Announcement
Onto before split announcement, when the underlying stocks split under options contract then the contract adjusted in a way that it doesn’t affect the holder either. The price of an underlying security adjusted during a stock split and any change in prices due to split do not affect option’s value.
The adjustment it undergoes named “being made whole” which has some sort of calculations.
But, don’t worry! It is pretty straightforward.
As you know that in option trading, each options contract controls 100 shares of an underlying security at a strike price. So, to calculate the new share ownership after the split is by taking the split ratio and multiplies by 100. And the new strike price will be generated by taking the old one and dividing by the split ratio.
For example, a buy option that controls the 100 shares of some ABC Company with a strike price of $100. If the ABC announces 2:1 stock split, then the contract would control 200 shares and strike price will be adjusted to $501.
However, in reverse split, the adjustment process also reverses. For example, if you buy a call option that controls 100 shares of ABC Company with a strike price of $10 and after ABC announces 1:5 stock split, the contract would control 20 shares with a strike price of $50.
If we talk about after split announcement then there are no adjustments in the price of underlying security since the price already sets post-split.
Final Thoughts: –
Even though the stock split has no value addition or wealth benefits for shareholder and it certainly doesn’t affect the market capital. But, it surely increases the no. of shares in options contract which may affect your options trading plan.
Nevertheless, stock splits have no direct harm to the shareholder and the company.
If you have any query or would like to add something then please don’t forget to mention in the comment section below.