Filed Under Beginner Options Trading. Options University More Contact Details. The key to understanding options stock splits is that the stock split cannot change the total value of the company and therefore cannot change the total value of your position. The key to understanding how stock splits affect your options is to understand that if a stock split cannot change the total value of the stock then it cannot change the total exercise value of your options. If the stock does a 2: You will then control twice as many contracts, or two for this example.
Your options are packaged a little differently but the total exercise value is the same. If the stock does a 3: You then own three times as many calls. Recall that fractional splits are anywhere the split ratios have a last digit greater than one, such as 3: Fractional splits affect options in a similar way as the whole number splits we just reviewed.
However, they create a small problem because the number of shares is not increased in units of To alleviate the problem, the exchanges decided to adjust the number of shares each contract controls. If the stock does a 5: All options, calls and puts, are adjusted in the same way. In addition, all short positions are adjusted in the same way as the long positions.
After all, the short position is simply on the other side of the trade from the long position. The multiplier stays the same. The market price of the stock, the strike price of your option, and the market value of the option are always reduced divided by the split ratio regardless of the type of split.
The following chart may help you to see the differences. Notice that the procedures for the strike price and market price are the same regardless of the type of split. There is another type of split called a reverse split, which is done for the opposite reasons of a stock split. Many times this is done so that the company meets certain listing requirements in order to trade on a nationally recognized exchange.
Reverse splits are most often seen in the penny stocks or other troubled stocks looking for a boost in price and hopefully awareness.
However, they can occur. If they do, the math previously described works exactly the same way but in the reverse direction. The company may vote for a 1: This just means that shareholders will receive one share for every three they currently own and the price will rise by a factor of three. Nothing has changed; only the packaging. Whenever you see this notation, be sure to check the number of shares it controls.
If you inadvertently sell a call that controls shares rather than there could be potential problems if the stock price rises substantially.
In essence, you would be short 50 shares of stock. Just as you should develop habits of checking option symbols when entering orders, you should also check to see if the total cost of the trade is roughly what you think it should be before sending the order.More...