What Are Non-Standard Options and Why Do They Exist?

Options contracts are financial instruments that provide the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price, known as the strike price, before or on a specific expiration date. These contracts derive their value from the performance of the underlying asset, which can include stocks, commodities, indices, or currencies. Most options traded on exchanges are standardized, meaning they have uniform contract sizes, fixed expiration cycles, and round-number strike prices. This standardization helps facilitate ease of trading and promotes liquidity in the market.

While most options are standardized, some options contracts deviate from these terms. These are known as non-standard options, arising from circumstances that alter their original characteristics. Understanding these contracts is important, as their differences impact how they are traded, valued, and managed.

Defining Non-Standard Options

A non-standard option is an options contract with modified or custom-created terms. Adjustments preserve the option’s economic value after events affecting the underlying asset. Unlike standard options, which typically represent 100 shares and have fixed strike prices and expiration dates, non-standard options lack uniformity.

Options become non-standard through adjusted strike prices. Strike prices might change to fractional amounts, like $49.73, reflecting corporate actions. Contract sizes can also adjust from 100 shares, representing 105, 98, or even 25 shares after a reverse stock split.

Changes in the underlying asset also lead to non-standard options. After a merger or spin-off, an option might represent shares of a different company, a combination of shares from multiple companies, or cash and shares. These altered terms mean the option’s deliverable is no longer 100 shares of a single stock.

Exchanges or clearinghouses often identify non-standard options through specific designations. They might receive new CUSIP numbers or special series designations. Brokerage platforms may append a number or “NS” (non-standard) to the symbol (e.g., “ABC1” instead of “ABC”), or display “ADJ” in the description.

Reasons for Non-Standardization

Non-standard options primarily arise from corporate actions affecting the underlying security. These actions necessitate adjustments to ensure the option holder is not unfairly disadvantaged or advantaged. The goal is to preserve the option contract’s intrinsic value and overall equity or obligation.

Stock splits frequently cause non-standardization. In a 2-for-1 stock split, the strike price is typically halved, and the number of contracts might double to maintain total value. Conversely, a reverse stock split (e.g., 1-for-5) increases the strike price and decreases shares per contract, or results in a sub-100 share deliverable.

Mergers and acquisitions also trigger adjustments. If an underlying company is acquired, the option might adjust to reflect merger terms, such as a cash payout or exchange for acquiring company shares. Similarly, a spin-off (where a company separates a division) can lead to options on the original company adjusting to include shares of the new entity.

Special dividends, especially large, one-time payments, can also cause options to become non-standard. To prevent value dilution, the strike price may adjust downward by the dividend amount. The Options Clearing Corporation (OCC) determines these adjustments, publishing memos outlining specific changes for each corporate action.

Beyond corporate actions, some non-standard options are created through over-the-counter (OTC) agreements. These private, custom contracts are negotiated between two parties, allowing flexible terms for strike prices, expiration dates, and underlying assets. Not exchange-traded, they are inherently non-standard from inception and can be tailored to specific needs or hedging strategies.

Valuation and Market Implications

The non-standard nature of these options implies several considerations for their valuation and market behavior. Standard option pricing models, like Black-Scholes, are designed for standardized contracts. Non-standard options, with unique strike prices, contract sizes, or underlying assets, require model adjustments or more complex valuation approaches to assess fair value.

Liquidity is another consideration for non-standard options. Because their terms are unique and not uniform, they are generally less liquid than standardized options. Reduced liquidity means wider bid-ask spreads and fewer willing buyers or sellers, making it challenging to enter or exit positions at favorable prices.

Market quoting and identification for non-standard options differ from standard ones. Exchanges or brokerage platforms typically use special symbols, numeric suffixes to the ticker, or designations like “ADJ” or “NS” to indicate adjusted status. Information on these adjusted terms is available through the Options Clearing Corporation (OCC) or the listing exchange, often via detailed memos.

Despite altered terms, the exercise and assignment process for non-standard options generally follows standard principles. However, actual delivery or cash settlement upon exercise or assignment reflects the adjusted terms. For instance, an option might require delivery of 105 shares, a fractional share amount, or a combination of cash and shares, as specified by the adjusted contract.