FAZ 1:10 Reverse Split ? What Happen To The Options?

Posted by Kris | Monday, July 13, 2009 | , | 0 comments »

Reverse splits are getting more common nowadays as reverse split gives a "perception" that the stock price (usually badly hammered stocks) are going higher after the split. Which is false actually. Take for example AIG which is trading now at 14.43 . Pre-split it was trading at ~1++. Because AIG is a 1:20 reverse split, right now it is trading LOWER before the split. In a bear market, reverse split happens while splits happen during bull market. Because of my "young" stock trading experience, i did not see alot of splits happening during the 2004-2007 bull run as compared to the heydays of the tech stock boom.

Example below shows the calculated/changes to the option value pre and post reverse split for FAZ. (From OCC)

Stock Splits: "Other" Splits (16 of 17)

1 for 10 reverse split

Before a
1 for 10 reverse stock split, an investor holds an option, call or put, on 100 shares of XYZ stock with an exercise price of $10. After adjustment for the split, the investor will hold one XYZ option on 10 post-split shares, but with the same exercise price of $10.

For an Option Holder:# of Contracts Strike PriceMultiplierAggregate
Pre-split Aggregate Value:1x$10x100=$1,000
Post-split Aggregate Value1x$10x100=$1,000

In this case, an XYZ stock investor is issued 1 share of stock for each 10 outstanding shares of stock already held, so the contract’s unit of trade is adjusted to 10 shares of the underlying stock. The number of contracts held, the strike price, and the aggregate value of the investor’s option, $1,000, remains the same. However, upon exercise of this post-split option, 10 shares of post-split XYZ stockwill change hands at the $10 strike price, effectively at $100 per share ($1,000 ÷ 10 = $100).

For Covered Call Writer:# of Contracts Unit of Trade# equivalent sharesXYZ shares held
Pre-Split:1x100 shares=100vs100
Post-Split:1x10 shares=10vs10

In this case, the ratio between the option’s equivalent number of shares and XYZ shares held and covered by the written call options remains 1 to 1.

Detailed Scenario

Below is a chart indicating typical adjustments to symbology and unit of trade for XYZ January options after a 1 for 10 underlying stock reverse split.

Observe above that the pre-split option symbol
XYZ has been changed to ZYX on the split’s ex-date. Strike price codes as well as expiration month codes remain the same – strike prices and expiration months are not adjusted because of a split. NOTE: The stock symbol for the new split stock may or may not remain XYZ after the split. This is determined by the primary exchanges on which the stock is traded.

If, for example, you hold
5 XYZ JAN 10 calls before the split, or XYZAB contracts, you will then automatically hold 5 ZYX JAN 10 calls, or ZYXAB contracts, on the ex-date for the split and afterwards.

Alternatively, if you had written, and were short
5 JAN 10 calls before the split, you will then automatically be short 5 JAN 10 calls on the ex-date for the split and afterwards.

In either case, OCC (and your brokerage firm) will have made the adjustment to your option position for you.

Generally 1 business day after the ex-date for the 1 for 10 split, the option exchanges on which the contracts are traded will generally list a new class of options reflecting the new price of the post-split stock. These “new” options will have standard strike prices, as well as standard strike price codes as possible. The option symbol for these new options will be determined by the option exchanges as well.

NOTE: If you wish to close out some or all of your adjusted calls after the ex-date, it will be necessary to buy or sell adjusted JAN 10 calls, designated ZYXAB(previously designated XYZAB), not a new post-split Jan 10 call if one exists. Negligence in this matter could lead to your establishing new positions in an unadjusted (or “new”) option series rather than closing out existing positions in adjusted series.

The premiums you’ll pay or receive for these adjusted contracts continue to be 100 times the price quoted in the marketplace. However, when one of these adjusted option contracts is exercised by its owner, 10 shares of the newly split stock will change hands at the strike price.

In-the-money vs. Out-of-the-money

When XYZ split 1 for 10, the contract deliverable for existing calls and puts was adjusted: 100 pre-split shares x 0.10 (1 ÷ 10) = 10 post-split shares. When determining whether an adjusted contract is in- or out-of-the-money, a current post-split stock price must be multiplied by the same 0.10 to adjust to a pre-split value.

For instance, if XYZ is at a price of $115 after the split, a January 10 call, seemingly $105 in-the-money, would actually be exactly in-the-money by only $1.50. To see this more clearly, if XYZ is at $115, its adjusted, pre-split equivalent value would be calculated $115 x 0.10 = $11.50.

Consider the Jan 10 call’s aggregate exercise amount (or contract value): $10 strike x 100 multiplier = $1,000. Compare this to the current contract deliverable value of $115 per XYZ share x 10 shares = $1,150. In this scenario, to buy the call for its in-the-money amount you’d pay “$1.50,” or $150 ($1.50 x 100 multiplier). To receive its in-the-money amount you’d sell the call for $1.50.