Options In Focus: Option Splits II
Stock splits carry with them special concerns for options traders. In Thursday’s article, we explored some basic split types and their impact on positions involving either Calls or Puts. In today’s piece, we’re picking up with a 3-for-2 split in Brookfield Asset Management () and working through the associated math to remove any mysteries that might be present.
For holders of Brookfield Asset Management options on June 1, a 3-for-2 or 1.5-for-1 stock split was going to make their positions look slightly askew the following Monday on June 4th. In Thursday’s article we left off posing the question of what would happen to a +3 Call position. Without the elves at the Options Clearing Corp and our brokerage putting +4.5 Calls into our accounts, which they won’t, something would have to give. And something does of course. In this “odd” split situation, it’s the multiplier beneath the surface which keeps our aggregate value or cost basis in check.
Let’s take a look at an example position in BAM Calls, before and after its split, to better appreciate the mechanics. Let’s assume a trader has purchased +3 July 65 Calls for 1.50, which represented the mid market close on June 1. The aggregate value is 3 x 1.50 or $450 for the position. On June 4, if one were to pull up an options matrix on BAM, they’d find that the July 65 strike had been converted (65 / 1.5) into the July 43.37 Strike. Further, if the Calls closed at 0.80 s by day’s end. That represents a loss of 0.20, as an unchanged value would be 1.00 (1.50 pre split / 1.50). At this point, there shouldn’t be any problems with the math involved. However, some scratching of the head over a 0.20 price shaving in the options, with BAM stock down just 0.14 on the day, is another situation / potential problem altogether.
A loss is never fun, even if it’s still an unrealized and tolerable one in the scheme of things. However, in the case of BAM, if the same positioned trader pulled up their trading account and didn’t know any better, by looking at the number of contracts and the P & L for the day; they’d likely need an aspirin as well. The reason being, they’d see the account still maintained +3 Calls, but was down -$60 for the session. How’d did the Call premium drop from 1.50 pre-split to 0.80 post split, the contract count remain the same, but only result in a loss of $60 bucks?
The answer is the multiplier involved. Since this type of odd split doesn’t allow contract adjustments due to the possibility of non-whole numbers being involved, the new premium levels must be multiplied by 1.50. In this instance, 0.80 x 1.50 = 1.30; which when multiplied by the three contracts ’still’ in inventory we come up with an aggregate value of $390. With an initial cost basis of $450, by finding the difference of the two, we come up with the $60 P & L swing.
Hopefully the process of what happens to existing option positions in front of a stock split is clearer. Additionally, as it relates to those “odd” situations, if traders are looking to open up a position and the strikes do appear funny looking, check with your broker as to the pricing involved, before acting. Generally, new classes of options will be rolled out with standard strikes and multipliers of 100 shares per contract; and that’s where fresh trader interest will likely be, if any.
Finally, if you do find yourself needing to close out an adjusted (pre-split) position, make sure the option code of your inventory matches what you’re trying to exit, as the old symbol code will have changed if new options were listed. Otherwise, some mostly easy math could turn into a financial problem not so easily handled. If questions are still unanswered or more details wanted, traders can turn to the Option Industry’s Council website (888options.com) or my forum at Optionetics.com.
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