Monday, May 25th, 2020

What Happens to a Call Option if a Company Splits Up?

 

How to trade stock options can vary with sometimes unforeseen circumstances. For example, what happens to a call option if a company splits up? What happens if the company merges with another company? How about when dividends are paid? For options traded on the CBOE, the Chicago Board Options Exchange, options are adjusted to fit the circumstances of dividend payments and other factors that affect the value of the stock on which a call or put is purchased or sold.

These are a few of the questions raised and answered on the CBOE web site. If one holds a call option on a stock will he receive a dividend paid for the stock? The answer is no. You need to own the stock in order to receive the dividend. In other words you need to exercise the call option on or before the In-dividend date in order to receive the dividend. The price of an option will typically fall after the In-dividend date as the holder of the option will not be able to exercise the option and receive the dividend. Back to the original question and regarding dividends what happens to a call option if a company splits up before the In-dividend date? The more important date here may well be the Declaration date. This is when the company board of directors declares a dividend. If a company is in trouble and about to be split up it may forego declaring a dividend, which will reduce the value of the call option. Succeeding in options trading requires that an options trader keep track of such events as they affect the stocks on which he is trading options.

In regard to exercising the option and the value of the option what happens to a call option if a company splits up? This falls under contract adjustment. To quote the CBOE, “Whenever the terms of an equity option contract have been changed to terms different from its original standardized terms, such as the contract’s deliverable (unit of trade) after an underlying stock split, or corporate action such as a take-over, merger or special stock or cash distribution, those terms will be adjusted to account for this.” For the options trader knowing when and how a contract’s terms have been adjusted is basic to how to buy stock options. The first hint of a contract adjust will typically be a seemingly mispriced option. In other words the option price will not seem to fit the underlying stock price and the strike price of the option. This will especially be true if all put and call prices are far different that when one might expect. The trader can check the contract adjustments area of the CBOE web site for bulletins regarding adjustments made due to special distributions, mergers, stock splits, or more damaging news such as a company splitting up.

A contract adjustment is what happens to a call option if a company splits up. To quote the CBOE site again regarding “other types of corporate action” than stock splits, “such as mergers, take-overs, spin-offs, and special distributions of cash and/or stock, adjustments fit the circumstances and terms of each action, and these vary from situation to situation. If you have, or are contemplating an option position in any class of options that is undergoing contract adjustments, be on the alert. Make yourself fully aware of what the adjustments are and how they may affect you financially.” In short, what happens to a call option if a company splits up can have a dramatic effect on call option price and needs to be attended to promptly to avoid significant loss. How to trade options in these cases is to be aware and check out discrepancies promptly.

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