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Ask Trader Guy: How the Options Look After a 7-1 Split

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August 1, 2014

Q: Why do my AAPL* options look so strange after the stock split 7-1?

T: No matter how strange things look, remember that the split itself doesn’t change the value of your position.

That said, let’s look at an AAPL option pre- and post-split. If the August 560 put is trading for 14.00 and has .33 delta pre-split, it would be worth about 100 more if AAPL dropped 3.00 (with all other things being equal) and the 560 put rose to 15.00. Post-split, the price of AAPL was 1/7th of the pre-split price, and all the option strike prices were adjusted down to 1/7th, too. 

So, the 560 put turned into the 80 put and might be worth about 2.00. But the single 560 put turned into seven 80 puts. A single 560 put at 14.00 has a 1400 value, and 7 80 puts at 2.00 also have a 1400 value. Now, the delta of the 80 put will still be about the same as the 560 put, .33. And if AAPL drops the same percentage post-split as pre-split, a 3.00 drop would be about .43. That means the 80 put would increase by about .142. Since you have 7 of the 80 puts, 7 x 14.20 = 99.40, which is nearly the same as the pre-split change in value. That means the risk of your position doesn’t change from pre- to post-split.

Q: Hey, Trader! When I look at options, I usually see that out-of-the-money (OTM) puts have a higher price than OTM calls that are the same distance out of the money. And sometimes I see stocks whose OTM calls are higher than the OTM puts. What’s going on and why?

T: That, my friend, is volatility skew in action. Vol skew, for short, is when the implied volatilities of the options in a particular expiration aren’t all the same. If you look at a graph of the implied vols, they usually slope up, and away, from the ATM strikes. And the slope is often steeper for the OTM puts than the OTM calls. This is because investors often buy OTM puts as a hedge against long stock, and sell OTM calls as either a covered call, or to finance buying the put. That buying-and-selling pressure drives the implied vols of the puts higher than the calls, which in turn makes the puts look more expensive than the calls. But when calls are more expensive than the puts, the slope of the call skew is steeper than the put skew, and that can happen when the stock has a lot of speculative activity. Investors who believe a stock might make a big move higher may buy calls, which can drive those particular values, and implied vols, higher.

Q: Hey, Trader! Greetings! My name is Zyphro and I come from the year 2514. I wish to bestow upon you all the Fed announcements from your time until mine so your future self can be wealthy!

T: Um, thanks Zyphro, but even if I knew what the Fed numbers were going to be, I’d still have no idea which way the market would move. Seriously, that stuff is a coin flip. Interpreting Janet Yellen’s statements is a job all by itself. I’m too busy actually trading. But if you know the future, can you tell me if this burrito I’m about to eat will keep me up all night?