What Happens to Options When a Stock Reverse Splits?

A reverse stock split consolidates existing shares into fewer, proportionally more valuable shares. For example, a 1-for-10 reverse split means ten old shares become one new share, and the stock price increases tenfold. This changes the number of shares owned and the price per share, but not the total value of an investor’s holdings. The economic value of options positions remains consistent after the split, even as contract terms change.

How Option Contracts are Adjusted

The Options Clearing Corporation (OCC) standardizes adjustments to option contracts following corporate actions like reverse stock splits. The OCC ensures fairness and consistency across the market. These adjustments ensure the intrinsic value of an option contract remains unchanged, preventing either the option holder or writer from being unfairly disadvantaged. The OCC publishes information memos detailing specific adjustments for each corporate action.

The strike price of an option contract adjusts after a reverse stock split. This adjustment occurs by dividing the original strike price by the reverse split ratio. For instance, in a 1-for-10 reverse split, an option with a $10 strike price becomes a $100 strike price, reflecting the increased per-share value of the underlying stock. This ensures the option’s exercise value remains economically equivalent.

The number of underlying shares represented by each option contract also changes proportionally. While standard option contracts typically represent 100 shares, a reverse split reduces this number. For example, a 1-for-10 reverse split means each contract now represents 10 shares (100 shares (1/10)).

The number of option contracts held by an investor generally remains the same. The underlying shares per contract are reduced to reflect the consolidation of shares in the underlying stock. This means an investor will still hold the same quantity of contracts, but each contract will control fewer, higher-priced shares of the underlying asset. This approach maintains the overall economic exposure of the option holder.

Calculating New Option Terms

New option terms are calculated using proportional adjustments. For example, if ABC Corp. announces a 1-for-10 reverse stock split, an investor holding a call option on ABC Corp. with an original strike price of $5.00 would see this term change. The new strike price is $5.00 multiplied by 10, equaling $50.00.

The number of shares represented by each option contract also adjusts. If a standard option contract represented 100 shares of ABC Corp. before the 1-for-10 reverse split, the new contract will represent a reduced number of shares. This is calculated by dividing the original 100 shares by the reverse split ratio, which is 100 / 10, resulting in 10 shares per contract. This means the option contract is now considered “non-standard” because it does not cover the typical 100 shares.

When a reverse split results in fractional shares, such as a 1-for-3 reverse split, an original 100-share contract would become 33.33 shares. Upon exercise or assignment of such an adjusted option, the handling of these fractional shares typically involves a cash settlement for the fractional part. The holder would receive whole shares for the integer portion and a cash equivalent for the remaining fraction, ensuring the total value is fully accounted for.

For instance, if an option contract after a 1-for-3 split represents 33.33 shares and is exercised when the stock is trading at $30, the holder would receive 33 whole shares and a cash payment equivalent to the value of 0.33 shares at $30. This ensures that the economic value of the fractional portion is delivered, even though physical shares cannot be fractionalized. Brokers automatically manage these calculations and settlements, reflecting the adjusted terms in the investor’s account.

Implications for Option Holders

Adjustments to option contracts following a reverse stock split have several practical implications for option holders, particularly concerning market dynamics and portfolio management. The non-standard nature of these adjusted contracts, which no longer represent the traditional 100 shares, can significantly impact their liquidity in the market. This often leads to wider bid-ask spreads, making it more challenging to buy or sell these specific contracts at favorable prices.

The premium value of an option contract also undergoes changes, even though the intrinsic value remains proportionally the same. While the total value represented by the contract is preserved, the “per contract” premium will appear different due to the change in the number of underlying shares. For example, if a contract previously covered 100 shares and now covers 10, the dollar premium quoted for that single contract will reflect the smaller share quantity, potentially making it seem less valuable at first glance, but the overall economic exposure is unchanged.

The process of exercise and assignment for these adjusted, non-standard contracts also adapts to the new terms. When an adjusted option is exercised, the holder receives the new, reduced number of shares per contract. If the adjustment resulted in a fractional share component, the fractional part is typically settled in cash. For option writers, being assigned on an adjusted contract means delivering the reduced number of shares and potentially a cash equivalent for any fractional share portion.

Option holders must accurately interpret their adjusted positions within their brokerage accounts. Brokers typically update the contract specifications to reflect the new strike price and shares per contract, sometimes even changing the option symbol. It is important for investors to review these details carefully to understand their current exposure and potential obligations. This diligent review helps in managing the altered position effectively.

Complex option strategies, such as spreads or combinations, might require re-evaluation after a reverse split. The altered share quantity per contract can affect the intended delta or gamma exposure of these strategies, potentially impacting their risk-reward profile. Investors employing such strategies may need to adjust their positions or consider closing them and re-establishing new ones based on the post-split standard option chain to maintain their desired market exposure.