When a company announces a 3-for-2 stock split, strange things happen to its options. The options contracts have to be adjusted to account for the changes, and that's not the only situation that prompts adjustments in options contracts. Situations that prompt adjustments include stock splits and reverse splits, mergers, takeovers, reorganizations, special cash or stock distributions and spin-offs.
Those who have been trading options for a while know a little about what to expect in the options market when a company announces a split or some other change impacting its options. At least, they think they do.
Mike Babel of the American Stock Exchange would like you to know that if you're still referring to your years-old copy of McMillan's Options as a Strategic Investment or other reference guide to figure out how options are adjusted under these conditions, your information might be wrong. Rules for handling option contract adjustments changed as of September, 2007. While 2-for-1 and 4-for-1 splits are handled as they were in the past, all other splits are handled differently, for example.
The reasons for the changes were two-fold. For the most part, those changes now keep the multiplier for the equity options at 100, something that wasn't always true of prior adjustment practices. In addition, the changes were meant to avoid rounding strike prices, something that sometimes occurred with prior adjustment practices. When an adjustment results in a partial share, something that can't be conveyed to the holder, cash is instead given in lieu of that partial share if the option is exercised.
Babel warns traders that it's their responsibility to keep up with news affecting the stocks or equity options they hold, as well as any important dates related to mergers, spin-offs or other such developments that might impact options contracts. After a company announces a change that will impact options, the by-laws (Article VI, Section 11) of the Options Clearing Corporation charges the OCC's adjustment panels with making the appropriate changes. These panels work under the OCC Security Council and are made up of two representatives of each exchange on which the impacted options are traded and one OCC representative who votes on changes only if there is a tie. These panels consider each change on a case-by-case basis. After a decision is made, bulletins are posted on the OCC's site as well as those of each exchange on which that company's options are traded.
For example, a look at the OCC's home page on December 11, 2008 shows "Contract Adjustments" listed on the upper right-hand side of the home page. Underneath is "Important Notices," which also includes options adjustments.
Upper Right-Hand Side of the OCC's home page:
Memo #25229, listed there, includes a cash-in-lieu settlement figure for Star Bulk Carriers Corporation. The new deliverable for the exercised options included cash in lieu of .4 fractional shares, the notice stated. That statement provided other details of the adjustment. Record dates and other such important dates are typically included in such bulletins.
Future Options 101 articles will detail some examples of contract adjustments, but those who don't want to wait can locate further information on Babel's webinar, offered by the OIC's site. This link may bring you to a sign-in page, but registration requires only an email address. For those who have specific questions about options in a company that is currently undergoing one of these changes requiring adjustment in its options, the OIC touts itself as being available to answer such questions by telephone inquiry, too. Just don't ask them questions about your specific option position, such as whether you should hold onto a call or put position. They can offer information on adjustments as well as general information about options stragegies but not about your specific position.