Stock split & dividend adjustments

We previously discussed stock splits and stock dividends. You learned why companies use them and how they affect stock positions. When a stock split or stock dividend occurs, option contracts on that stock are also adjusted.

Forward stock splits A forward stock split increases the number of shares outstanding and lowers the price per share. Start with this option position:

Long 1 ABC Jan $200 call (right to buy 100 shares @ $200)

When a forward stock split occurs, the contract is adjusted based on the split type. There are two types of forward splits: even and uneven.

Even stock splits An even stock split is easy to spot: if the split ratio ends in 1, it’s even. For example:

2:1 stock split 4:1 stock split 10:1 stock split

With even stock splits, the option adjustment changes:

the number of contracts the strike price

But the shares delivered at exercise (per contract) stays the same.

Assume this position again:

Long 1 ABC Jan $200 call (right to buy 100 shares @ $200)

What would the contract become if ABC stock was subject to a 2:1 stock split?

Answer: Long 2 ABC Jan $100 calls

To calculate the adjustment, use the stock split factor we learned previously.

First, find the factor:

Divide the first number by the second number: 2/1 = 2

Stock split factor = 2

Next, adjust the number of contracts:

1 contract × 2 = 2 contracts

Last, adjust the strike price:

$200 ÷ 2 = $100

So the investor goes from 1 long $200 call to 2 long $100 calls.

Let’s see if you can make the same adjustments. Again, assume this position:

Long 1 ABC Jan $200 call (right to buy 100 shares @ $200)

What would the contract become if ABC stock was subject to a 5:1 stock split?

(spoiler)

Answer: Long 5 ABC Jan $40 calls To calculate the adjustment, use the stock split factor.

First, find the factor:

5/1 = 5

Stock split factor = 5

Next, adjust the number of contracts:

1 contract × 5 = 5 contracts

Last, adjust the strike price:

$200 ÷ 5 = $40

So the investor goes from 1 long $200 call to 5 long $40 calls.

Uneven stock splits

An uneven stock split uses a ratio that does not end in 1. For example:

3:2 stock split 5:4 stock split 7:2 stock split

With uneven stock splits, the option adjustment changes:

the strike price the shares delivered at exercise (per contract)

But the number of contracts stays the same.

Assume this new position:

Short 1 XYZ Sep $90 put (obligation to buy 100 shares @ $90) What would the contract become if XYZ stock was subject to a 3:2 stock split?

Answer: Short 1 XYZ Sep $60 put (covering 150 shares)

We’ll use the stock split factor to calculate the adjustment.

First, find the factor:

3/2 = 1.5

Stock split factor = 1.5

Next, adjust the strike price:

$90 ÷ 1.5 = $60

Last, adjust the shares delivered at exercise:

100 shares × 1.5 = 150 shares

So the investor goes from an obligation to buy 100 shares at $90 to an obligation to buy 150 shares at $60.

Let’s see if you can adjust for an uneven split. Again, assume this position:

Short 1 XYZ Sep $90 put (obligation to buy 100 shares @ $90) What will the option contract become if a 5:4 stock split occurs on XYZ stock?

(spoiler)

Answer = Short 1 XYZ Sep $72 put (covering 125 shares) We’ll use the stock split factor to calculate the adjustment.

First, find the factor:

5/4 = 1.25

Stock split factor = 1.25

Next, adjust the strike price:

$90 ÷ 1.25 = $72

Last, adjust the shares delivered at exercise:

100 shares × 1.25 = 125 shares

So the investor goes from an obligation to buy 100 shares at $90 to an obligation to buy 125 shares at $72.

Reverse stock splits

A reverse stock split reduces the number of shares outstanding and raises the price per share. Option contract adjustments are handled the same way as uneven forward splits.

Assume this new position:

Long 1 MNO Dec $10 put (right to sell 100 shares @ $10)

What would the contract become if MNO stock was subject to a 1:4 reverse stock split?

Answer: Long 1 MNO Dec $40 put (covering 25 shares)

We’ll use the stock split factor to calculate the adjustment.

First, find the factor:

1/4 = 0.25

Stock split factor = 0.25

Next, adjust the strike price:

$10 ÷ 0.25 = $40

Last, adjust the shares delivered at exercise:

100 shares × 0.25 = 25 shares

So the investor goes from a right to sell 100 shares at $10 to a right to sell 25 shares at $40.

Let’s see if you can adjust for a reverse split. Again, assume this position:

Long 1 MNO Dec $10 put (right to sell 100 shares @ $10)

What would the contract become if MNO stock was subject to a 1:20 reverse stock split?

(spoiler)

Answer: Long 1 MNO Dec $200 put (covering 5 shares) We’ll use the stock split factor to calculate the adjustment.

First, find the factor:

1/20 = 0.05

Stock split factor = 0.05

Next, adjust the strike price:

$10 ÷ 0.05 = $200

Last, adjust the shares delivered at exercise:

100 shares × 0.05 = 5 shares

So the investor goes from a right to sell 100 shares at $10 to a right to sell 5 shares at $200.

Stock dividends

Stock dividend contract adjustments use the same process as uneven forward splits and reverse splits. Stock dividends are quoted as a percentage, for example:

10% stock dividend 15% stock dividend 25% stock dividend

Assume this new position:

Short 1 ZZZ Apr $55 call (obligation to sell 100 shares @ $55) What would the contract become if ZZZ stock was subject to a 10% stock dividend?

Answer: Short 1 ZZZ Apr $50 call (covering 110 shares)

First, determine the stock dividend factor:

Convert the dividend to a decimal: 10% = 0.1

Add it to 1: 1 + 0.1 = 1.1

Stock dividend factor = 1.1

Next, adjust the strike price:

$55 ÷ 1.1 = $50

Last, adjust the shares delivered at exercise:

100 shares × 1.1 = 110 shares

So the investor goes from an obligation to sell 100 shares at $55 to an obligation to sell 110 shares at $50.

Let’s see if you can adjust for a stock dividend. Again, assume this position:

Short 1 ZZZ Apr $55 call (obligation to sell 100 shares @ $55) What would the contract become if ZZZ stock was subject to a 25% stock dividend?

(spoiler)

Answer = Short 1 ZZZ Apr $44 call (covering 125 shares) We’ll use the stock dividend factor to calculate the adjustment.

First, find the factor:

25% = 0.25 1 + 0.25 = 1.25

Stock dividend factor = 1.25

Next, adjust the strike price:

$55 ÷ 1.25 = $44

Last, adjust the shares delivered at exercise:

100 shares × 1.25 = 125 shares

So the investor goes from an obligation to sell 100 shares at $55 to an obligation to sell 125 shares at $44.

Sidenote

Adjustments for cash dividends Options are generally not adjusted if a cash dividend is paid by the underlying stock’s issuer. This is true for regular, quarterly dividends that are predictable. For example, Coca-Cola Co. (symbol:KO) has been paying consistent quarterly dividends for over 50 years. No adjustments are made to Coca-Cola options due to their predictable nature. On the other hand, options contracts are adjusted for special dividends, which are unexpected dividend payments. These can come from stocks that pay regular dividends or those that generally don’t pay dividends. Costco (symbol: COST) is an example of a company that pays regular quarterly dividends, but also pays a special dividend on occasion. In 2020, the company paid a quarterly dividend of $0.70 per share. At the end of the year, Costco’s Board of Directors announced a special dividend of $10 per share. While the usual quarterly dividends did not result in adjustments to Costco options, the special dividend reduced all strike prices by $10.

For example, let’s assume an investor owns this option:

1 COST Jan 550 call (covering 100 shares)

After the $10 special dividend, the option would become:

1 COST Jan 540 call (covering 100 shares)

Key points

Option contract adjustments

Required for stock dividends or splits

Even forward stock splits

Stock splits with a ratio ending in 1

Option contract adjustments:

More contracts

Lower strike price

Same shares delivered at exercise (per contract)

Uneven forward stock splits

Stock splits with a ratio not ending in 1

Option contract adjustments:

Same number of contracts

Lower strike price

More shares delivered at exercise (per contract)

Reverse stock splits

Option contract adjustments:

Same number of contracts

Higher strike price

Fewer shares delivered at exercise (per contract)

Stock dividends

Option contract adjustments:

Same number of contracts

Lower strike price

More shares delivered at exercise

Cash dividends

Options are not adjusted for regular cash dividends

Options are adjusted for special cash dividends

Same number of contracts

Strike price reduced by the amount of dividend

Same shares delivered at exercise