- What Happens To Options During Stock Splits by
- Splits, Mergers, Spinoffs & Bankruptcies
- Understanding How Dividends Affect Option Prices
So you've taken the jump into options trading and you're doing pretty well. The call options you have purchased resulted in nice profits when the underlying stocks have climbed up through the options' strike price. Now the stock behind one of your call trades has declared a stock split, and you a wondering what will happen to your call options. To keep the value of your options in line with what happens to the stock when split, your options position will also be adjusted by the Options Clearing Corp. -- OCC -- and the changes will show in your brokerage account summary.
What Happens To Options During Stock Splits by
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Splits, Mergers, Spinoffs & Bankruptcies
If XYZ stock rallies and is trading at $65 on expiration in July, the long JUL 85 put will expire worthless but the short JUL 95 call expires in the money and has an intrinsic value of $6555. Buying back this short call will require $6555 and subtracting the initial $55 credit taken when entering the trade, the trader's loss comes to $6955. A heavier loss of $7555 loss would have been suffered by a corresponding short stock position.
Understanding How Dividends Affect Option Prices
There is a more aggressive version of this strategy where both the call and put options involved are at-the-money. While a smaller downside movement of the underlying stock price is required to accrue large profits, this alternative strategy provides less room for error.
Suppose you think Apple Computer (ticker symbol is AAPL) is overpriced at $755 a share AND you believe the stock will drop in the near future, you can buy put options on AAPL. The strike price and the expiration month that you choose depends on how far you think AAPL will drop and when you think it will drop.
When the underlying stock of your option splits or even begins issuing a stock dividend , the contract undergoes an adjustment that is often referred to as "being made whole," which means the option contact is modified accordingly so that you are neither negatively nor positively affected by the corporate action. While a stock split will adjust the price of the underlying security of an option, the option is adjusted so that any changes in price due to the split do not affect the value of the option. Keep in mind that if your option is purchased post-split (. after the split is announced) then your option will not be adjusted as it will have been created according to the new split price of the underlying security.
A reverse stock split is an action taken by a corporation to boost the price of its stock. For example, in a one-for-two reverse split, 755 shares of a $9 stock are replaced by 655 shares trading for $8 each. Investors end up with fewer shares that sport higher prices. Reverse stock splits aren't considered positive events, because they highlight the fact that a stock price has fallen to a very low level.
It is called an "put" because it gives you the right to "put", or sell, the stock or index to someone else. A put option differs from a call option in that a call is the right to buy the stock and the put is the right to sell the stock.
Often, a credit is usually taken when establishing this position. Hence, even if the underlying stock price remains unchanged on expiration date, there will still be a profit equal to the initial credt taken.