How Stock Splits Affect Options

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Stock Splits
Stock splits can happen for a variety of reasons, but even if you're only trading the options, you're still impacted by any changes that happen in the underlying shares.

There's no reason to panic, and there's nothing you need to do. But when companies attract big-money investors and share prices start soaring, it's good to know what could be on the horizon for some of your investments.

For example, many stocks rally to $100 in relatively short order if they break above $75. Some of the psychology behind this technical behavior is that buyers believe that once shares reach $100, companies will be inclined to announce a 2-for-1 or 3-for-2 stock split. And many companies do just that -- split their stock.

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What Do Stock Splits Mean For You?
What does this mean, exactly? In the case of a 2-for-1 split, the stock that's worth $100 per share will be broken in half. So, the long-side investor who holds one share at $100 will thus be given two shares valued at $50 apiece.

The original dollar amount invested doesn't change; the delivery, however, gives you additional leverage. If you had 1,000 shares of that $100 stock, you'll still have a $100,000 position -- just with 2,000 shares at the lower dollar amount.

The same goes for the options. If you've got 10 contracts of the XYZ Aug 60 Calls and the stock splits 2-for-1, you will get twice as many calls at the lower strike price, or 20 contracts of the XYZ Aug 30 Calls, on a split-adjusted basis.

A New Option?
Because it's technically a "new" option, your position will be given a new ticker symbol because the stock is now trading at $30 and there would be no need to have options with the $60 strike be available for trading after the stock split.

If you're establishing an options position after a split has taken place, the tickers and values will have already been adjusted to reflect the change because the "old" strike prices have been taken off the board as of the effective distribution date.

It's not uncommon for stocks to split every few years -- for example, YUM! Brands (YUM), parent company of KFC, Taco Bell and Pizza Hut -- had two splits in a five-year period. It is up to a company's leadership and board members to decide whether a split is warranted; otherwise, there are no set rules about when or if a split will take place.

Stock splits are widely perceived to be a positive move, because the lower price and additional liquidity means that more investors can (and might) jump in to trade those names."

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