What Happens to Options When Stocks Split?

When a company announces a stock split, and you happen to hold an options position on that underlying stock, what happens to your options? Here's what you need to know.

Stock splits are just one type of corporate action. Others include cash dividends, stock dividends, spin-offs, mergers, and acquisitions. Although big corporate announcements tend to get the most headlines, corporate actions—big and small—happen every day.

Many corporate actions require adjustments, which can include the number of outstanding shares and/or the share price as well as the terms of listed options contracts, such as strike prices and/or multipliers. Those types of alterations often result in contract terms that fall outside the standard 100-share contracts. For that reason, modified contracts are often called "non-standard options."

As far as splits go, a two-for-one split is relatively common and straightforward. For every share held as of the record date, an investor will receive two shares as of the ex-date. After the split, each share—all else being equal—will be worth half of what it was pre-split.

Let's look at another example: A four-for-one split. If a company's shares are trading at $400 per share, and an investor holds 100 shares, after the split, they'll hold 400 shares, each worth $100. Note that the value of the position doesn't change; the value is $40,000 before and after the split. To learn more, refer to this primer on stock splits.

It all starts with the Depository Trust & Clearing Corporation (DTCC), a clearing and settlement agent for U.S. securities transactions. The DTCC determines how shares will be adjusted before and after a corporate action like a stock split.

For options, there's the Options Clearing Corporation (OCC), which is the central clearing firm for all standardized options listed in the United States. Although the OCC makes adjustments on a case-by-case basis, options are typically modified for stock splits based on a few standard adjustments (see table below). Investors can confirm via the OCC website. Actual contract adjustments will be detailed in an information memo.

How will a split affect the options? You can refer to the table above for general guidelines, however the DTCC and OCC will set the official terms. For example, using the guidelines above and returning to the four-for-one split example, suppose it's the ex-date and shares were trading at $430. In addition to owning 100 shares of a stock, suppose an investor is long a 400-strike put and short a 380-strike put (380-400 long put vertical spread). After the ex-date, all else being equal, they'd own 400 shares of the stock at $107.50 each. Instead of one put vertical spread, they'd own four—but the strikes would be divided by four as well. The 400-strike becomes the 100-strike, and the 380-strike becomes the 95-strike (four 95-100 long put vertical spreads).

The options prices would change as well. Just as the stock price is adjusted to one-fourth of the pre-split price after a four-for-one split, all else being equal, an option worth $2 would be worth roughly $0.50.

In the case of a whole split—like two-for-one or four-for-one—the multiplier and delivery terms stay the same. A standard options contract is still deliverable into 100 shares of stock. In the case of odd split, such as three-for-two or four-for-five, the number of contracts typically stays the same and the strike price is adjusted. The deliverable is adjusted as well. The deliverable will be set to what a 100 share position in the underlying became as a result of the corporate action. It is unusual for the multiplier to be changed from 100 but it can occur in unique circumstances.

A split or other corporate action typically requires no action on the part of the investor. Positions adjust accordingly. But here are a few things to consider.

Expiration dates matter. Remember to pay attention to ex-dates for splits. Options expiring before that date are still based on the pre-split price, but anything on or after the ex-date will be based on post-split pricing.

What happens to non-standard options and liquidity? If an investor happens to hold a position in a non-standard option after the adjustment, it's up to them to decide whether to hold or attempt to close the position. Generally, non-standard options have less liquidity and wider-than-normal bid/ask spreads. When a corporate action has resulted in a non-standard option position alternatives to consider include:

• Maintain the position, factoring in liquidity concerns
• Close the non-standard option and open a position in the new standard options, when issued
• Close the position and seek other opportunities

What about those greeks? Options greeks are calculations that measure the options sensitivity to changes in certain parameters affecting the underlying security.

Delta measures how much the options premium is expected to change for each $1 move in the underlying stock. Say an investor holds one option with a .40 delta on an underlying stock that's trading for $100 before a four-for-one stock split. After the stock split, all else being equal, the stock is adjusted to $25, and each option is adjusted to a new position in four contracts at one-fourth the price. The delta of each post-split option stays the same at .40. So, after the adjustment, instead of holding one contract, they'll hold four and a $0.25 move in the $25 stock should have the same impact on the resulting options position as a $1 move in the pre-split stock that was trading for $100 would have on the original option position, barring other factors.

Theta, in contrast, measures the expected change in options premium for each day that goes by and will change to reflect the adjustment in the options contract. When a stock sees a four-for-one split, for example, theta per option will be one-fourth what it had been. The investor now owns four options after the split, so the math for the aggregate position will be the same pre- and post-split.

The same goes for vega, which tracks the relationship between implied volatility and options premium. After a four-for-one split, a 1% move in volatility will have one-fourth the effect on each option, but if you have four of them, it'll be the same aggregate exposure.

When a new investor is exposed to the dynamics of a split, it can be a bit confusing. A conventional stock split is a fairly clean increase of position size and a strike price adjustment and doesn't affect the value of an options position. It only means that the investor will be holding a greater number of contracts at a lower price. However, a non-standard corporate action may not be as straightforward and may require a deeper evaluation of the changes to the position. Because of the potential complexities involved, it's important for investors to fully understand the official terms of the spilt, as well as understanding the risks involved and the possible lack of liquidity in these options.