What Happens To Options During Stock Splits
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What Happens To Options During Stock Splits - Introduction
"What Happens To Options During Stock Splits?" This is perhaps one of the first questions beginner option traders ask shortly after option trading for real. This is an extremely important question to answer as stock splits does happen often and not knowing what's going on definitely throws every amateur options trader into disarray and confusion, leading to all the wrong actions.
What Happens To Options During Stock Splits - What Is A Stock Split?
A stock split happens when a company "splits" its shares up into smaller portions while maintaining overall share capital. A company with
10,000 shares trading at $50 can split into 20,000 shares of $25. This is what we commonly call a 2 for 1 split and which is the most common form
of stock split. If you are holding shares 100 shares of that company at $50 before the split, you will end up with 200 shares of $25 after a
2 for 1 split. But what happens when you are holding options instead?
What Happens To Options During Stock Splits?
When a stock splits, the OCC or Options Clearing Corporation, automatically adjusts your options holding through your option trading broker
to reflect the proportion of the split such that you too will end up with a net position value which is equivalent to before the split.
If you own 1 contract of $50 strike price
call options on the company mentioned above valued at $2 per contract on the day of a 2 for 1 split, you will
end up with 2 contracts of $25 strike price call options valued at $1 per contract. Let's look at the net effect of the split:
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Before Split
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After Split
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1 Contract of $2 @ $50 Strike
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2 Contracts of $1 @ $25 Strike
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100 x $2 = $200
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200 x $1 = $200
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This is also the same treatment if you owned employee stock options. Options that underwent such adjustments are known as Adjusted Options.
What Happens To Options During Stock Splits - The Drawback
While this adjustment to your
stock options may seem like a fair deal, it does change some things. First of all, it increases the number
of options contracts that you are holding, which may or may not conform to your option trading plan. The more options contracts you are
holding, the higher the real dollar loss in the short term should the stock take a ditch. Let's assume that the company's stocks fall from
$25 to $24 right after the stock split.
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Assuming Stock Falls From $25 To $24
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Before Split
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After Split
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1 Contract of $2 @ $50 Strike
Delta 0.50
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2 Contracts of $1 @ $25 Strike
Delta 0.50
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($1 x 0.5) x 100 = $50 loss
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($1 x 0.5) x 200 = $100 loss
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 Beginner option traders who
do not fully understand position management or trade management should stay away from buying options on stocks that are slated for a
stock split.
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