Corporate actions such as stock splits, special dividends, mergers and acquisitions are quite common, but what happens with unexpired options?
It seems like each month or so there's a major company announcement—a mega-merger, acquisition, stock split, or a special dividend—but these are just the big ones we hear about. In actuality, such events, commonly referred to as "corporate actions," occur pretty much every day, at companies big and small.
Typically, a corporate action will require adjustments to be made to the number of outstanding shares and/or the share price, and, depending on the type of action, the stock symbol may also change. The terms of listed option contracts, too, are often adjusted; depending on the specifics, certain option contract terms and obligations, such as the strike price, multiplier, or the terms of the deliverable, could be altered. And because these alterations often result in contract terms that fall outside the standard, 100-share contracts, they are often referred to as "non-standard options."
Sound intimidating? It doesn't need to be. Remember, these adjustments are made in order to keep valuations and obligations intact after a corporate action. For example, suppose Company XYZ announces a 3-for-1 split as of a specific date (the "adjustment date"). Suppose you own 100 shares as of the adjustment date, and on that date the company stock is trading at $150 a share. After the split, you'd own 300 shares, each worth $50 a share. The shares are valued at $15,000, both before and after the split.
Suppose further that you had purchased a 75-strike put option that is set to expire after the adjustment date. Although the actual terms will be decided by a committee (see the next section below), after the adjustment is made, you'd likely hold 3 put option contracts, each with a strike price of 25. All other terms would likely remain the same. Once again, from a fundamental standpoint anyway, nothing has changed.
In the world of option adjustments, even splits like the example above are relatively straightforward. Others, such as an odd-ratio split (like 5:4 or 3:2), or an acquisition involving fractional share transfer or cash-and-stock, can get complex. And oftentimes, strike prices won't be a round number, but rather rounded to the nearest penny.
In general, when a corporate action is announced, the company will notify the Depository Trust & Clearing Corporation (DTCC), which provides clearing and settlement services for U.S. securities transactions. DTCC determines how shares will trade pre-event.
The OCC, the central clearer for listed options in the U.S., then determines how these changes will be reflected in options. The OCC Securities Committee and an "adjustment panel," comprising two representatives from each exchange that lists that company's options, plus one OCC representative, decide whether an adjustment is called for, and how it should be structured. The decision is binding to all investors.
A detailed memo on each corporate action and any resulting adjustment determinations is posted to the OCC website. The options exchanges will usually issue adjustment memos on their websites as well. Although adjustments are determined on a case-by-case basis, each type of corporate action is typically adjusted per table 1 below.
You'll generally find no free money just sitting there after an adjustment. Today's ultra-fast, ultra-sophisticated algorithmic trading systems calculate theoretical values of adjusted options and squeeze out any pricing inefficiencies in the blink of an eye.
If you see an option that appears priced too good to be true, it may be unwise to jump in without doing your homework. It's probably best to do your some more research; you're likely missing something.
And if you find yourself with a position in non-standard options due to an adjustment, should you liquidate? There's no right or wrong answer—remember, the fundamentals don't change; the terms are adjusted to keep the fundamentals intact. However, some nonstandard options can have less liquidity and wider-than-normal bid-ask spreads. So, at minimum, it may not make sense to establish new positions once options are adjusted.
The best way to know for certain that you have an adjusted options position is to check the OCC website for any memos related to the company in question. But there are a few warning signs as to whether an option has been adjusted:
And if you're still not sure, it's best to contact your broker. TD Ameritrade clients can contact a specialist for help, or email email@example.com.
Get step-by-step TradeWise trade ideas from former floor traders delivered directly to your inbox. At checkout, enter coupon code "ticker."
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
*When the two months have passed, keep the TradeWise service
for just $20 per strategy per month.
TradeWise Advisors, Inc. and TD Ameritrade, Inc. are separate but affiliated
firms. Advisory services are provided exclusively by TradeWise Advisors, Inc.
and brokerage services are provided exclusively by TD Ameritrade, Inc. For more
information about TradeWise, please see ADV 2 on www.tradewise.com.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2021 Charles Schwab & Co. Inc. All rights reserved.