What do equities and boy bands have in common? At some point, they might split. Admittedly, when a split does occur, it creates a big mess. Fortunately, we’re not talking about boy bands today, but instead, how to close out of options that become non-standard due to a standard split or reverse split.
First, let’s review what stock splits are and what they do to your position. You want to remember that after any stock split that your total share value does not change. If you had $10,000 worth of stock, then you’ll end up with $10,000 worth of stock after a standard split or reverse split. It is the number of shares and the share price that will change.
To determine whether your underlying position is going through a standard or reverse split then just look at the first number of a split announcement.
- Standard stock splits start with the larger number: 2:1, or 2 shares for each share of stock
- Reverse splits start with a smaller number: 1:2, or 1 share for every 2 share of stock.
Generally speaking, standard stock splits are a lot easier to comprehend than reverse splits, but let’s go through examples.
Standard Stock Split: 2 For 1
Original position: 100 shares @ $100.00, one $105 short call (covered call)
Position after Split: 200 shares @ $50.00, two $52.5 calls
Formula for standard stock splits:
Formula for new strike price after a standard split:
After a standard split, your overall exposure stays the same. Since options control 100 shares of stock and we have a clean split here then you would end up with 200 shares @ $50 and as well as 2 calls @ $52.5 strike.
Reverse splits can also occur. This one is a little more difficult to understand so hang in there.
Reverse Stock Split: 1 for 4
Original position: 100 shares @ $5.00
Position after split: 25 shares @ $20.00
Let’s do another example with a formula: 2 for 3 Reverse Split
Original position: 100 shares @ $12.00, one $15 short call (covered call)
Position after split: 66* shares @ $18.18 , one non-standard $15 call for 66 shares instead for 100 shares.
*Since 100 multiplied by ⅔ = 66.66 fractional shares (.66) will turn into cash.
Formula for reverse stock splits:
In the 2:3 reverse split example above, the call may appear to be in-the-money because the market price of the stock after the split is greater than your original $15 strike. That is not the case though. It still has the same notional value of $1,500. Since the reverse split reduced the overall number of shares outstanding, the option is only in control of 66 shares instead of the standard 100. The $15 standard option you originally sold has now changed into a non-standard option due to the reverse split.
To learn how to view a non-standard (NS) options position on an options chain then, please click here.
To learn more about the margin requirement of a reverse split, then please click here.