What Happens to Call Options When a Stock Splits?

When a stock splits, call options are adjusted to reflect the new stock price and the increased number of shares. This adjustment ensures that option holders maintain the same economic position they had before the split, preserving the intrinsic value of their contracts. The Options Clearing Corporation (OCC) handles these adjustments automatically, ensuring a seamless transition.

Understanding Stock Splits and Their Impact

Before diving into the specifics of option adjustments, let’s briefly revisit what a stock split is and why companies do it. A stock split is a corporate action where a company increases the number of outstanding shares by issuing more shares to current shareholders. The total market capitalization of the company remains the same, but the price per share decreases proportionally. For example, in a 2-for-1 stock split, each shareholder receives one additional share for each share they already own, and the stock price is halved.

Companies typically split their stock to make it more affordable and attractive to a broader range of investors. A lower stock price can increase trading volume and potentially boost market capitalization over time.

Call Option Adjustments After a Stock Split

The core principle behind adjusting call options after a stock split is to ensure that the economic value of the option contract remains unchanged. This is accomplished by adjusting both the strike price and the number of shares covered by the option.

Here’s how it works:

• New Number of Shares: The number of shares covered by the option contract is increased by the same ratio as the stock split. For a 2-for-1 split, the number of shares covered increases from 100 to 200.
• New Strike Price: The strike price is reduced by the same ratio as the stock split. For a 2-for-1 split, the strike price is halved.

Example:

Let’s say you own a call option with a strike price of $100, covering 100 shares of Company XYZ. Then Company XYZ announces a 2-for-1 stock split.

• Before Split: 1 call option contract controls 100 shares with a strike price of $100 per share.
• After Split: 1 call option contract now controls 200 shares with a strike price of $50 per share.

The overall value of the contract remains the same. Before the split, the contract gave you the right to buy 100 shares at $100 each. After the split, it gives you the right to buy 200 shares at $50 each.

The Role of the Options Clearing Corporation (OCC)

The OCC plays a crucial role in managing these adjustments. It acts as the central clearinghouse for all listed options in the United States, ensuring that all contracts are properly adjusted following corporate actions like stock splits. The OCC publishes information about upcoming adjustments on its website, providing details about the adjustment ratios and the new terms of the option contracts.

Investors don’t need to take any specific action. The adjustments are applied automatically by brokers and the OCC. Your brokerage account will reflect the new strike price and number of shares covered by your options.

Fractional Shares and Cash Adjustments

Sometimes, a stock split might result in fractional shares. For example, a 3-for-2 stock split on a standard 100-share option contract would result in the option covering 150 shares. In such cases, the strike price is adjusted accordingly to reflect the increased number of shares. More complex splits, or those involving odd ratios, may also involve a cash adjustment. This means that, in addition to adjusting the strike price and number of shares, the option holder might receive a cash payment to fully compensate for the split. The OCC will provide specifics on any cash adjustments if they are necessary.

Importance of Monitoring Your Options

Although the adjustments are automatic, it is still crucial to monitor your option positions following a stock split. Check your brokerage account to ensure that the adjustments have been applied correctly. Understanding the new terms of your contracts will help you make informed decisions about whether to hold, exercise, or sell your options.

Frequently Asked Questions (FAQs)

Here are some frequently asked questions about call options and stock splits:

FAQ 1: Will a reverse stock split affect my call options?

Yes, a reverse stock split will also affect your call options, but in the opposite way compared to a regular stock split. In a reverse split (e.g., 1-for-2), the number of shares decreases, and the strike price increases proportionally. So, if you had an option to buy 100 shares at $10, after a 1-for-2 reverse split, you would have an option to buy 50 shares at $20.

FAQ 2: What happens to the premium I paid for the call option after the split?

The premium you paid for the call option is not directly adjusted. However, the market value of the adjusted option will reflect the new stock price and adjusted strike price. Whether the option’s value increases or decreases depends on how the underlying stock price performs after the split.

FAQ 3: Are all stock splits handled in the same way by the OCC?

While the principle remains the same – maintaining the economic value of the option – the specifics can vary depending on the split ratio. The OCC provides detailed information for each specific stock split, including adjustment factors and potential cash adjustments.

FAQ 4: How do I find out if a stock I own options on is splitting?

Your brokerage firm will typically notify you of any corporate actions, including stock splits, that affect your holdings. You can also find this information on financial news websites, company press releases, and the OCC’s website.

FAQ 5: If I sell a covered call before a stock split, am I still obligated to deliver the shares after the split?

Yes, you are still obligated to deliver the adjusted number of shares at the adjusted strike price. The covered call is adjusted to reflect the new terms of the option contract.

FAQ 6: Can I exercise my call option immediately after the stock split?

Yes, you can exercise your call option immediately after the stock split, but you need to consider the adjusted strike price and number of shares. It’s crucial to evaluate whether exercising the option is economically beneficial, given the current market price of the stock.

FAQ 7: What happens if I have a call option on a stock that is acquired?

If the company is acquired, the call options may be adjusted to reflect the terms of the acquisition. This could involve changing the underlying asset to shares of the acquiring company or providing a cash payment. The OCC will determine the appropriate adjustment based on the acquisition agreement.

FAQ 8: Does a stock split affect the expiration date of my call option?

No, a stock split does not affect the expiration date of your call option. The expiration date remains the same as it was before the split.

FAQ 9: Where can I find the official adjustment details from the OCC?

The OCC publishes official adjustment notices on its website (www.theocc.com). Look for the “Information Memos” section, where you can find details about adjustments for specific corporate actions.

FAQ 10: Are adjustments for stock splits different for European-style options versus American-style options?

No, the adjustment process for stock splits is the same for both European-style and American-style options. The style of the option refers to when the option can be exercised (European options can only be exercised on the expiration date, while American options can be exercised at any time before the expiration date), but it does not affect how stock splits are handled.

FAQ 11: What should I do if I believe my call options were not adjusted correctly after a stock split?

Contact your brokerage firm immediately. They can investigate the issue and make any necessary corrections. If the problem persists, you can contact the OCC directly for further assistance.

FAQ 12: How do these adjustments affect my taxes?

The adjustment of call options due to a stock split is not typically a taxable event on its own. The adjustments are considered a continuation of your original investment. However, when you eventually sell or exercise the adjusted options, the tax implications will depend on your individual circumstances and holding period. It’s best to consult with a tax professional for personalized advice.