Even experienced traders may wonder what happens to options when companies like Amazon and
Tesla announce stock splits.
Will the sudden change in price mean a big gain or a big loss?
Hi, I’m Barbara Armstrong, and this is Comment Below.
We’ve had a few people ask what happens to options after a stock split.
A conventional stock split occurs when a company divides its existing shares into more shares.
The number of shares increases, but the price of each share decreases proportionally, so
the total value of the company’s shares remains the same.
Because of the underlying price drop, it may seem like options would suffer a big gain
or loss, but it doesn’t work that way.
Instead, options on the stock that split are adjusted automatically, so if you have a position
in those options, you typically don’t have to do anything.
However, it’s still important to understand the mechanics.
Let’s start with an example.
On March 9, 2022, Amazon announced a 20-for-1 split.
In order to participate in the stock’s split, an investor must own a share by the May 27
record date.
Then each share will become 20 shares as of the ex-date the day the stock starts trading
at the new adjusted price which is June 6.
After the split, each share all else being Equal will be worth one-twentieth of its
pre-split price.
When a stock split is planned, the Options Clearing Corporation, or OCC, determines options
contract adjustments that may include the number of contracts, strike prices, and multipliers.
Adjustments are made on a case-by-case basis, but there are typical adjustments that are
the same whether you’re dealing with calls or puts.
For example, for a whole split like a 2 for 1, 3 for 1, 20 for 1, and so forth, the number
of contracts is increased, and the strike price is reduced by the same ratio as the
stock price.
The contract multiplier stays the same at 100.
Let’s look at an example.
Suppose Amazon closes at $2,300 per share the day before its ex-date.
You have a vertical put spread where you own a put with a strike at 2320 and you sold a
put with a strike at 2300.
On the ex-date, the stock splits 20 for 1, which means that for every one share investors
own, they now own 20 shares, and the price of the stock is now $115 per share.
Now, let’s look at your options positions.
Instead of one vertical put spread, you now own 20 but the strikes would be divided
by 20 as well.
The 2320 strike becomes the 116 strike and the 2300 strike becomes the 115 strike.
The options prices would change too.
Options prices are set by supply and demand, so the theoretical values would be around
one-twentieth their previous value.
An options contract that was worth $100 would now be worth roughly $5.
The options multiplier remains 100, and it still delivers 100 shares of stock.
The options greeks should remain the same in the aggregate as they were before the adjustment.
In other words, if you had one contract but now you have 20 contracts, the 20 contracts
together will act the same as the previous single larger contract.
Delta measures the change in options price in relation to the underlying stock price.
Delta won’t change because the strike price and the stock price are changed by the same
ratio.
Theta is the relationship between the options premium and time.
The theta per option will be one-twentieth what it had been.
But if you own 20 options, the math for the aggregate position will be the same pre- and
post-split.
The same goes for vega, which tracks the relationship between implied volatility and the options
premium.
After the split, a 1% move in volatility will have one-twentieth the effect on each option,
but if you have 20 of them, it’ll be the same aggregate exposure.
However, not every stock split is so clean.
An odd split like a 3-for-2 or a 5-for-4 is a little different.
The number of contracts remain the same, but the strike prices are split by the same ratio
as the share price.
There may also be adjustments to the multiplier.
These alterations often result in contract terms that fall outside the standard 100-share
contracts, which are called non-standard options.
Option traders affected by a stock split should consider the following.
First, pay attention to where the expiration date of your options fall in relation to the
split ex-date.
For example, Amazon set its split ex-date for June 6, 2022.
Options expiring before then would still be based on the pre-split price, but anything
after the ex-date would be adjusted to reflect the post-split pricing.
Second, if you end up with an adjusted option, it’s up to you to decide whether to hang
on or liquidate.
An adjusted option is often very cheap or very expensive.
You may see two different options symbols with the same month and strike price, the
abbreviation ADJ may appear in the description, and a number may be added to the underlying
stock symbol.
Some non-standard options can have less liquidity, which may mean wider-than-normal bid/ask spreads
that could cut into your gains or add to your losses.
It may be unwise to add to adjusted options positions.
Third, confirm the details of any split that may affect you.
The OCC posts information memos about adjustments resulting from each stock split, so check
the memo to be sure you understand the details.
Once you understand the dynamics of a split, you’ll likely find it to be pretty intuitive.
Just make sure you confirm the details and are prepared for when the split occurs.
And if you have any other questions, comment below.