What happens to my option when a company declares a split, share issuance or a special dividend? The answer depends on when the shares, dividend or split is to occur with relationship to your options expiration month. If the shares will hit the secondary market (the exchanges) before your options expire, your option will be adjusted and then represent a non-standard contract.
For instance, in a 2 – 1 split, options that represented 100 shares will now represent 200 shares. This “adjustment” is performed by the Options Clearing Corporation and your brokerage is supposed to inform you of the change.
If you’d like to see an actual announcement from the OCC – Here’s a current one related to a3 for2 split by Steve Madden Ltd. http://www.optionsclearing.com/componen……
So basically, your financial rights end up pretty much the same, simply adjusted to account for the split, new issuance, special dividend, whatever. What many folks don’t think about though is that because your now adjusted option is “different” from standard options contracts, it becomes much less liquid! Once your option has changed from a normal standard 100 share/contract type option, it becomes less desirable and less tradable. I’ll bet that you can guess what happens to the bid/ask spread and the daily volume! Yup, not in your favor! So, what you find is that most seasoned traders will exit the position and reestablish the position with “normal” options. If you hesitate, you will simply find that the market for your adjusted options becomes smaller and smaller and smaller…
Take a look at this option chain for DIS – (courtesy of TradeMonster), you’ll see that the non standard options are identified by a different type font color and that the number of shares that the contract represents is presented. Note also how the Open Interest tends to be a bit lower for each strike price than a standard option.
One last note – typically, the options chain will reflect in some way that there are “non-standard” options for each expiration series. They may be in a different font color, or simply have a small explanation next to the expiration month. Check with your broker to find out how they identify the affected options.
Just keep in mind – if the value of an option looks to good to be true – it is… The value of the expected change has already been priced into the options. The markets’ kinda smart that way….
Jeff McAllister
OptionsANIMAL Instructor
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