What Happens to Options When a Stock Splits?

When a company’s stock undergoes a split, options contracts are affected. Stock options give the holder the right, but not the obligation, to buy or sell an underlying stock at a predetermined price (the strike price) before an expiration date. When a stock splits, existing options contracts are automatically adjusted to ensure the total value of the option position remains unchanged, maintaining economic integrity for both buyers and sellers.

Understanding Stock Splits and Options Basics

A stock split is a corporate action where a company increases its outstanding shares by dividing each existing share into multiple new shares. For example, a 2-for-1 split means one share becomes two, and the price per share approximately halves. This action makes individual shares more affordable and accessible to a broader range of investors. Conversely, a reverse stock split consolidates multiple existing shares into fewer, higher-priced shares, aiming to boost the stock price.

Stock options provide leverage, allowing investors to control more shares with less capital than buying outright. A call option grants the right to purchase shares, while a put option grants the right to sell shares. Each option contract specifies a strike price (the price at which the underlying stock can be bought or sold) and an expiration date. These contracts are standardized, with one contract typically representing 100 shares of the underlying stock.

Automatic Adjustments to Options Contracts

When a stock split occurs, the Options Clearing Corporation (OCC) automatically adjusts the terms of existing options contracts. This adjustment process ensures the total value of an investor’s options position remains equivalent to its value before the split. The core principle behind these adjustments is to “make whole” the option holder, preserving their economic position.

For a forward stock split, two primary adjustments are made to the options contract. The strike price of the option is divided by the split ratio. Simultaneously, the number of shares represented by each option contract is multiplied by the same split ratio. For example, a contract that previously represented 100 shares would now represent 200 shares after a 2-for-1 split. The number of contracts held remains the same, but their terms are modified.

For a reverse stock split, adjustments work in the opposite direction. The strike price of the option is multiplied by the reverse split ratio. Consequently, the number of shares underlying each contract is divided by the reverse split ratio. While most standard splits result in 100-share contracts, some odd-ratio splits, like a 3-for-2, may create “non-standard” contracts with a different number of shares.

Illustrative Examples of Adjustments

Consider an investor holding one call option contract on XYZ stock with a strike price of $100. Each contract controls 100 shares of XYZ. If XYZ announces a 2-for-1 forward stock split, the OCC will automatically adjust the option contract.

The original strike price of $100 will be divided by the 2-for-1 split ratio, resulting in a new strike price of $50. The number of shares controlled by the contract will be multiplied by the split ratio, changing from 100 shares to 200 shares. After the split, the investor’s single contract will give them the right to buy 200 shares of XYZ at $50 per share.

Now, imagine an investor holds one put option contract on ABC stock with a strike price of $20. If ABC undergoes a 1-for-5 reverse stock split, the option contract will be adjusted. The original strike price of $20 will be multiplied by the 5 (reverse) split ratio, resulting in a new strike price of $100. The number of shares controlled by the contract will be divided by the reverse split ratio, changing from 100 shares to 20 shares. The investor will then hold one contract giving them the right to sell 20 shares of ABC at $100 per share.

Another scenario involves a 3-for-2 forward stock split. If an investor holds a call option on DEF stock with a $60 strike price, the strike price of $60 would be divided by 1.5 (the 3/2 split ratio). The number of shares controlled by the contract would be multiplied by 1.5. This would result in a single “non-standard” contract for 150 shares at a $40 strike.

Important Considerations After an Adjustment

Following a stock split, option holders must verify their contract terms. Brokerage platforms reflect these adjustments automatically, though changes may take time to appear. Investors should review the new strike price and shares per contract to understand their adjusted position. The OCC also issues information memos detailing adjustments for specific corporate actions on their website.

The liquidity of adjusted option contracts can be affected, particularly after a split or with non-standard adjustments. While the OCC strives to maintain an orderly market, adjusted contracts might trade less frequently or under a different option symbol initially. This temporary change in liquidity could impact an investor’s ability to easily buy or sell their adjusted options at their desired price.

Understanding the timeline of a stock split is important. The ex-date is the first day the stock trades without the right to the split shares, and stock options are adjusted on or around this date. The effective date is when the new shares are issued. For options, adjustments align with these dates, ensuring options expiring before the ex-date use pre-split pricing, and those on or after use post-split pricing.

The adjustment of an option contract due to a stock split is not considered a taxable event. The Internal Revenue Service (IRS) views stock splits as merely a change in the form of ownership, not a realization of income or loss. However, any subsequent sale or exercise of the adjusted option contract would be a taxable event, and the cost basis of the option would need to be adjusted to reflect the split.