Splits, Mergers, Spinoffs & Bankruptcies

What happens if I am short calls in the stock of a company which is subsequently taken over before the expiration date?

Corporate actions such as mergers, acquisitions and spin-offs will often necessitate a change to the amount or name of security that is deliverable under the terms of the contract. When such adjustments occur, the short call position is responsible for delivering the adjusted security.

For example: The shareholders of company JKL Inc. have approved a takeover bid placed by Global Giant Co. As a result, holders of JKL stock will now be entitled to a 1/2 share of Global Giant for every share of JKL Inc. they own. Therefore, holders of JKL call options will now be entitled to a deliverable amount of 50 shares of Global Giant for every contract of JKL that they are long (100 shares per contract x .5 Global Giant). Investors with short positions in JKL call options would then be responsible for delivering 50 shares of Global Giant for every call option assigned.

For the sake of this example, a simple conversion ratio was used, though not all corporate actions result in such clearly defined terms. Often assignment will require the short position to deliver fractional shares plus cash equivalent. An adjustment panel consisting of representatives of the listing options exchanges and OCC (Who only votes in case of a tie) makes a determination whether to adjust an option as a result of a particular corporate action by applying general adjustment rules. Again, whatever the terms, the short position has the potential obligation of delivering the adjusted underlying.

For access to specific Contract Adjustment Memos, you may search by option root symbol here: http://www.theocc.com/webapps/infomemos.

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What happens with my options contracts when a company is delisted from an options exchange?

If a stock fails to maintain the minimum standards for price, trading volume and float prescribed by the options exchange, option trading can be wound down even before the stock is delisted by its primary market. In that case, no new series would be added at expiration. Trading in existing series would continue until they go "off the board". If trading in the underlying stock is suspended by its primary market for an extraordinary reason before the expiration of outstanding options, the options exchange will specify a procedure for the orderly liquidation of option open interest in a special bulletin.

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I was wondering if there is an industry standard to how options holdings are adjusted to reflect a stock split or stock dividend on the underlying security.

You can see a basic discussion on how options are adjusted in Chapter III - Options on Equity Securities from The Characteristics and Risks of Standardized Options.

Remember that each adjustment can be handled differently to reflect the unique terms of the stock adjustment. The Options Industry Council website offers an online interactive class regarding option contract adjustments that can occur as a result of a wide variety of corporate actions.

You can also find memos that pertain to all adjustments on the OCC website www.theocc.com.

We also offer customers an email alert pertaining to these memos.

If you have questions pertaining to a specific adjustment you can call an Options Professional at 1-888-OPTIONS (1-888-678-4667).

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How can I tell if an option contract has been adjusted?

There are several ways that an investor can confirm that an options contract has been adjusted and what the terms of the options contract are.

  • Information Memos
    OCC posts contract adjustment memos to its website that give detailed information as to how outstanding option contracts will be adjusted due to a corporate action.
  • Equity Special Settlement Report
    OCC provides a report that contains all options contracts with a non-standard deliverable.
  • Call 1-888-OPTIONS (1-888-678-4667)
    Investor Services is staffed with industry professionals who are well versed in discussing options contract adjustments and are able to review the specific details of all option contract adjustments.

Here are two hints that an option has been adjusted.

  • The option appears to be "mispriced." Review the whole option string or chain of options to see if this is pricing appears for call and puts in all strikes. It is highly unlikely that mispriced options exist for a whole option class. There are no free lunches in the financial markets. If they exist, market forces ensure they do not exist for very long.
  • Two option root symbols share the same strike price. In some cases, an adjusted non-standard contract will appear alongside a standard, 100-share contract. when looking at a string of option prices for a particular underlying look to see if all the symbols are identical. These contracts, while having the "same" strike price will have different option root symbols. In many cases, the price differences between these two contracts can vary significantly.
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XYZ Inc.'s stock was recently trading at .60 cents before undergoing a 1 for 10 reverse stock split and is now trading at $6.00. Is my call option with a strike of $5 that was outstanding at the time of the reverse split now in-the-money by $1.00?

No. The call option should not be in-the-money. All XYZ Inc.'s option contracts that were outstanding on the effective date of the 1 for 10 reverse split have would be adjusted to reflect the reverse split. An option contract for a reverse split is typically adjusted as follows:

  • Strike Price - No change
  • Number of Contracts - No Change
  • Multiplier - Strike Price and Premium Multiplier remains 100
  • New Deliverable per Contract - 10 shares of XYZ Inc.

The value of 10 NEW shares of XYZ Inc stock @$6.00 per share is $60.00 dollars. The value of the strike price (if exercised) is $500.00. To determine the point at which the post-split stock needs to be for the $5.00 call to be in the money, divide the value of the strike ($500.00) by the number of shares that Underlies the contract (10). This would indicate that the stock would need to be trading above $50 per share for this adjusted contract to be in the money.

For additional educational information concerning adjustments to options due to splits and mergers please refer to our online interactive classes. You can also view adjustment memos posted to the www.theocc.com website.

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How are options contracts adjusted for reverse stock splits?

Typically, a 1 for 20 reverse split would cause the option contract to be adjusted by changing the deliverable to 5 shares of the "new" stock. You can expect the 'contract multiplier' to remain 100, and of course the option symbol would most likely change to reflect a change in the deliverable securities. You may want to take a look at the PALM split, which was a 1 for 20 split, to study an actual situation.

Also, visitors have the opportunity to review how various corporate actions including reverse stock splits impact option contracts via our online interactive classes.

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I own a September call option for company XYZ. News has come out stating that XYZ is the subject of a cash buyout that is expected to close in May. Assuming that the merger is approved, what can I expect to happen to the call option I own.

When an underlying security is converted into a right to receive a fixed amount of cash, options on that security will generally be adjusted to require the delivery upon exercise of a fixed amount of cash, and trading in the options will ordinarily cease when the merger becomes effective. As a result, after such an adjustment is made all options on that security that are not in the money will become worthless and all that are in the money will have no time value.

Sign up for our Online Options Classes to learn more about how options are adjusted due to corporate actions.

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If you write a covered call and the stock splits 2:1 - what happens to my 50 call if the stock price is 45?

In your example, when the stock split becomes effective, the stock would go to $22.50 (45/2) and the new strike would be 25 (50/2). You would now own twice as many of the 25 calls.

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What is the deliverable on an option when the underlying security is converted to the right to receive cash?

As explained in Chapter III of the disclosure document:

"When an underlying security is converted into a right to receive a fixed amount of cash, options on that security will generally be adjusted to require the delivery upon exercise of a fixed amount of cash, and trading in the options will ordinarily cease when the merger becomes effective. As a result, after such an adjustment is made, all options on that security that are not in the money will become worthless and all that are in the money will have no time value." For instance, the in-the-money option holder can choose if he'd like to receive that cash value immediately (by exercising) or to wait for the contract to be exercised at expiration (allowing for his firm's exercise-by-exception thresholds).

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A company I own options in recently declared Chapter 11 bankruptcy protection. What does that mean for my options?

Following a bankruptcy announcement, trading in the underlying stock might be suspended by the primary exchange that lists the security. If trading in the underlying stock has been halted, trading on the options will be halted as well. However, if the underlying stock begins trading on the OTC Bulletin Board or on the "Pink Sheets", investors will be able to close out any existing positions, i.e., 'closing only' transactions. No new or 'opening' trades are permitted. Investors may also exit their position through exercise instructions to their broker resulting in the physical delivery of the bankrupt company's shares.

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How are options typically adjusted in the case of a merger where an election is involved?

An option's deliverable in the case of an election merger is usually adjusted based on the merger consideration, which accrues to non-electing shareholders. If call option holders do not wish to receive the non-electing consideration after the contract adjustment, they must exercise in advance of the election deadline. And as shareholders, they must elect pursuant to the election procedures described in the proxy statement/prospectus.

The Securities Committee takes each instance on a case-by-case basis. To find the adjustment for a specific election merger, search the Information Memos section on OCC's website.

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How is an option contract adjusted for a tender offer or an exchange offer?

According to Interpretation .03 to Article VI, Section 11, of OCC's By-Laws:

"Adjustments will not be made to reflect a tender offer or exchange offer to the holders of the underlying security whether such offer is made by the issuer of the underlying security or by a third person or whether the offer is for cash, securities or other property. This policy will apply without regard to whether the price of the underlying security may be favorably or adversely affected by the offer or whether the offer may be deemed to be "coercive." Outstanding options ordinarily will be adjusted to reflect a merger, consolidation or similar event that becomes effective following the completion of a tender offer or exchange offer."

Call option holders must exercise their option no later than the expiration date of the tender offer or exchange offer in order to tender shares. In all cases it is the sole responsibility of the person tendering to comply with all the terms and conditions of an offer.

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Are there new procedures for adjusting option contracts in the case of a cash dividend?

Yes, you will want to read this memo that was published by OCC for all details.

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What happens to the options on an equity if that company files for bankruptcy? Do the options keep trading until expiration date?

If a company files for bankruptcy and the shares still trade or are halted from trading but continue to exist, the options will settle for the underlying shares. Quite often, the shares begin trading on the Pink Sheets or over-the-counter if delisted from the national stock exchange where they are listed and when they do the options exchanges will usually announce that the options are eligible for "closing only" transactions – no opening positions are allowed. Generally, there are no exercise restrictions.

However, if the courts cancel the shares, whereby common shareholders receive nothing, calls will become worthless and an investor who exercises a put would receive 100 times the strike price and deliver nothing.

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