How do stock splits affect options holders?

In a recent forum post, TK client AlaskanKnight asked for help understanding how stock splits affect option holders, such as AK. Turns out this isn't nearly as simple as you'd like it to be.

AlaskanKnight writes: "NCI Building Systems, Inc. announced today that a 1-for-5 reverse stock split. Stockholders who hold their shares in street name will be contacted by their banks or brokers with any instructions. No fractional shares will be issued as a result of the reverse stock split. Fractional shares resulting from the reverse stock split will be aggregated and sold as whole shares in the open market by Computershare. Computershare will then allocate the proceeds of such sales to the record holders' respective accounts pro rata in lieu of fractional shares as soon as practicable. How does this affect me as an options holder?"


It doesn’t really affect you, AK.  Your options neither lose nor gain value as a result of this split.

But, this method of handling stock splits can be very confusing.  The first thing you must do is take the current stock price and divide it by 5.  That gives you the "true" stock price where your options are concerned.

Example:  Stock is $10.25.  Divide by five and the ‘true’ stock price post-split would be $2.05.

If you look at the Apr 5-strike put option, you think: “It’s $5.25 ($10.25 minus $5.00) OTM and worthless.”  In reality, it’s $2.95 points ITM because the "true" stock price for UYS options is $2.05. (Note: UYS will be the new ticker symbol for the merged company.)

Don’t trade these options.  Other that exiting your position at some time, just forget these UYS options.  It’s far too easy to make a mistake.

Here are some details:

NCS stock was trading near $2.  After the reverse split, the stock is now trading near $10 per share.  The option symbol is now UYS.  New options with the symbol NCS will be issued.  DO NOT confuse these options.  Pay attention to the symbol.

The deliverable for each option is now 20 shares at the same strike price.  But, it’s the "true" stock price described above.  If you owned one NCS May 2 call option, you had the right to buy 100 shares @ $2 per share.  Total cost if you exercise is $200.

Now, if you exercise you buy only 20 shares, but pay the same $200.  Why?  The strike price is 2 "true dollars" in post-split terms, which translates into 10 real-world dollars.  Very weird.

If you were short this option, and if assigned an exercise notice, you would be obligated to deliver 20 shares per call option.  You will be paid $2 (true price) multiplied by 5 per share.  Value: $200.

No gain, no loss for option traders.  But beyond confusing.

If you have a put position, the split transition is similar: The put owner has the right to sell 20 shares per contract and the put seller may become obligated to buy 20 shares.

If you need them, you can find more details here: http://www.cboe.com/publish/TTStockSM/10-095.pdf


Regards,
Mark Wolfinger
Founder, MDW Options
TradeKing All-Star Commentator

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