What Happens to Options When a Stock Splits?

An investor who owns call options on a stock that splits will wind up owning more options on the stock. However, having a larger number of options won’t increase the value of the options. That’s because the price of the underlying stock will be decreased when the stock splits. The change in stock price is directly related to the number of new shares that will be issued in the split. A 2-for-1 split would reduce the value of a $10 per share stock to $5 per share. There are other share-related events that can affect options, too. Consider working with a financial advisor as you pursue trading in options or other types of derivatives.

What Happens When a Stock Splits?

When a stock splits, existing shareholders get additional shares. For instance, if a corporation declares a 2-for-1 split, an investor holding 100 shares would then hold 200 shares. To account for stock splits, the price of shares affected by a split is adjusted. For instance, if a stock trading at $10 is split two for one, the price would drop to $5.

To account for stock splits, the price of shares affected by splits is adjusted. For instance, if a stock trading at $10 is split 2 for 1, the price would drop to $5.

Understanding Options and Stock Splits

Options are versatile financial instruments that give investors specific rights regarding stock purchases or sales. Two of the most common types are call options and put options, each offering unique benefits and risks.

Call Option: A call option is a contract granting the holder the right — but not the obligation — to buy a stock at a predetermined price, known as the strike price.
Put Option: In contrast, a put option gives the holder the right to sell a stock at a set strike price.

Each option contract specifies an expiration date, after which the contract becomes void. Typically, one option contract represents 100 shares of the underlying stock.

How Call and Put Options Work

The value of a call option is closely tied to the movement of the stock price:

In the Money (ITM): When the stock’s market price exceeds the strike price, the call option is considered in the money. For example, a call option with a strike price of $5 becomes valuable if the stock’s price rises to $10. The intrinsic value equals the difference between the market price and the strike price ($10 – $5 = $5 per share).
Out of the Money (OTM): If the stock price is below the strike price, the call option is out of the money. While OTM options may retain some speculative value before expiration, they become worthless if the stock price does not rise above the strike price by the expiration date.

Put options operate oppositely to call options. They are in the money when the stock price is lower than the strike price, as this gives the holder the right to sell the stock at a higher price than its current market value.

Events That Can Trigger Option Adjustments

Several corporate actions can affect the value of an option, leading to adjustments in the contract terms to ensure fairness:

Spinoffs: When a company spins off part of its business, the resulting changes in stock structure can lead to adjustments in the related options contracts.
Stock Splits: When a company declares a stock split, the share price drops accordingly, potentially impacting options contracts. Adjustments are made to reflect the new share price and volume without reducing the option’s value.
Reverse Stock Splits: In cases of reverse stock splits, the number of shares decreases while the price increases. Options contracts are adjusted to match the new stock structure.
Mergers and Acquisitions: If the underlying company merges or is acquired, options may be adjusted to reflect the new entity or value.
Special Dividends: The declaration of special dividends — either cash or stock — can also trigger adjustments to prevent the option holder from losing value.

Call and put options offer investors flexibility in buying or selling stocks at predetermined prices, but they come with distinct risk-reward dynamics. To navigate these instruments effectively, it is essential to understand how corporate actions, such as stock splits, mergers and special dividends, can impact the value of options contracts and lead to adjustments.

Additionally, timing and market analysis play a crucial role, as options that are out of the money at expiration become worthless. By staying informed and strategic, investors can leverage options as a powerful tool in their trading and investment strategies.

Adjustment Mechanics

Most options adjustments for stock splits are straightforward. For instance, if an investor has an option for 100 shares of stock with a strike price of $10, after an adjustment for a 2 for 1 split, the investor will hold two options. Each option represents 100 shares with a strike price of $5. The adjustment is done automatically by the Options Clearing Corporation (OCC), a derivatives clearinghouse. Investors don’t have to do anything to keep the value of their options unaffected.

Corporations may also declare other splits, such as 3 for 1 or 5 for 1. These work similarly. For instance, the holder of a call option on 100 shares of a stock with a strike price of $30 would, after a 3 for 1 split, own three options. Each call option would cover 100 shares with a strike price of $10.

For some splits, it’s more complicated. Corporations may, for instance, declare splits of 3 for 2. If this happens an option holder will still have the same number of contracts. However, each contract will be for 150 shares of stock instead of 100. The strike price will also be reduced so the value of the option contract is the same. A 4-for-3 split would result in each contract covering 133 shares. After a 5-for-2 split, each contract would represent 250 shares.

Reverse splits reduce the number of outstanding shares. After a reverse split, the price of the affected shares increases. For instance, a 1-for-2 reverse split would result in shareholders owning half as many shares, each worth twice as much. When options contracts are adjusted to reflect reverse splits, each contract represents a smaller number of shares with a higher strike price. An option for 100 shares at $10 would, after a 1-for-2 reverse split, cover 50 shares at a $20 strike price.

Bottom Line

When it comes to what happens to options when a stock splits, the answer is, not much. After a stock splits, share prices are adjusted to keep the value of the total number of outstanding shares unchanged. That could cause the value of options on affected shares to change dramatically. To avoid that, options – whether call or put – on stocks that split are adjusted so that the split doesn’t change the value of the options. The option contract adjustments are handled automatically by the options clearinghouse.

Tips on Investing

Trading options can expose investors to significant losses. Experienced and qualified financial advisors can help investors manage their risk and still meet financial goals. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
Use this asset allocation tool as you weigh your risk tolerance against various combinations of large-cap, mid-cap and small-cap shares.