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Understanding Adjusted Options

Understanding Adjusted Options

Key Points
  • Options may be adjusted if the underlying stock undergoes some type of reorganization. 

  • Read about how to identify adjusted options.

  • Find out how you might deal with adjusted options.

Understanding how options are adjusted when the underlying stock goes through some type of reorganization has never been easy, and the fact that the rules have changed several times over the years doesn't help.

The last change took place following the OCC's (formerly the Options Clearing Corporation) options symbology conversion in May 2010, yet this topic remains relevant for many options traders.

There are certain characteristics common to all option contracts:

  • Class: Call or Put
  • Style: American or European
  • Type: Equity or Index
  • Expiration Date: Varies
  • Symbol: Varies
  • Strike price: Varies
  • Multiplier: Initially 100
  • Deliverable or contract size: Initially 100

When the underlying company goes through some type of corporate reorganization, any of the last five items can change, resulting in an adjusted option. You have no control over whether these items will change, but an understanding of how and why they change can help you deal with them afterward.

The expiration date is a special case. It usually remains constant, but OCC can accelerate it when the underlying company undergoes a merger and the deliverable (the underlying shares) is converted into a 100% cash deliverable.

The causes for adjustments to options contracts are numerous. Below is a partial list that shows not only what causes the adjustment, but also what type of adjustment may occur. For example, when an ordinary cash dividend is paid, it typically has no effect on the option, whereas stock splits usually do.

Causes of adjusted options

 

Size/Type

Symbol

change

Strike price

change

Multiplier

change

Contract size

(deliverable)

change

Ordinary cash dividend1

 

No

No

No

No

Extraordinary cash dividend2

<$12.50/

contract

No

No

No

No

 

>$12.50/

contract

No

Yes: reduced

No

Sometimes

Stock dividend

All

Yes

Yes: reduced

Yes: increased

Yes: increased

Rights offering

 

Yes

No

No

Yes: increased

Spin-off

 

Yes

No

No

Yes: increased

Stock split

2 for 1

3 for 1

4 for 1

5 for 1

3 for 2

4 for 3

5 for 4

6 for 5

7 for 5

No

No

No

No

Yes

Yes

Yes

Yes

Yes

Yes: reduced

Yes: reduced

Yes: reduced

Yes: reduced

Yes: reduced

Yes: reduced

Yes: reduced

Yes: reduced

Yes: reduced

No

No

No

No

Yes: increased

Yes: increased

Yes: increased

Yes: increased

Yes: increased

No

No

No

No

Yes: increased

Yes: increased

Yes: increased

Yes: increased

Yes: increased

Reverse stock split

1 for 2

1 for 5

1 for 7

1 for 10

1 for 20

1 for 50

1 for 100

Yes

Yes

Yes

Yes

Yes

Yes

Yes

No

No

No

No

No

No

No

No

No

No

No

No

No

No

Yes: reduced

Yes: reduced

Yes: reduced

Yes: reduced

Yes: reduced

Yes: reduced

Yes: reduced

Merger or acquisition

Acquirer

Sometimes

No

No

No

 

Acquiree

Yes

No

No

Yes

Stock symbol or

company name change

 

Sometimes

No

No

No

1. Paid on a quarterly or other regular basis, regardless of amount.
2. Not paid on a quarterly or other regular basis.

Source: Schwab Center for Financial Research.

Following the 2010 option symbology conversion, when an option symbol change is required, an adjusted option will typically have the same symbol as the standard option, but a numeric digit (1, 2 etc.) will be added as a suffix to identify it as an adjusted option. The numeric digit doesn't describe the adjustment, it only indicates that some sort of adjustment has occurred.

Identifying adjusted options

There are several ways to help identify an adjusted option, starting with the way we just mentioned:

1. The underlying symbol within the option symbol is appended with a number (for example, XYZ1 10/20/2012 33.0 C).

2. The expiration header indicates that the options are adjusted.

3. The option seems much too cheap or too expensive.

Here's how an adjusted option may look in StreetSmart Edge® (the factors above are numbered in the screenshots):

Signs of an adjusted option

Signs of an adjusted option

Source: StreetSmart Edge®

There's another area within the option chains of StreetSmart Edge that will give you many of the details of how the option is structured after the adjustment. You can locate this screen by highlighting an option in the option chain, and clicking on the arrow at the beginning of the row. Look at the example below to see the contract specifications for XYZ1 October 20th, 2013 33.00 calls.

For this particular option, you can see that the reason it's trading at a price that's quite a bit higher than the standard 33.00 call is because it includes the delivery of 33 shares of ZYX and cash-in-lieu of $10.00 in addition to the 100 shares of XYZ. Looking at the expanded view, you may also find adjusted options where the contract size is greater than 100, options that include two or more different stocks, and options with a multiplier that's something other than 100. As noted above, all of these can occur when options are adjusted.

Contract specifications

Contract Specifications

Source: StreetSmart Edge®

Dealing with adjusted options

Adjusted options rarely represent a good trading opportunity. Always keep in mind the old adage: If it seems too good to be true, it probably is.

Don't panic if you already own an option position that goes through an adjustment—you won’t necessarily lose or gain any value as a result of the adjustment and, if your position is covered, your shares will also have been adjusted so that you remain covered. However, it's generally wise to avoid establishing new positions in options after they're adjusted.

Adjusted options often have the following characteristics:

  • Time values may be lower.
  • Spreads may be wider.
  • Volumes are usually lower.
  • Open interest is usually lower.
  • Bids may drop below intrinsic value near expiration.

When an option is adjusted (as in the example above) such that the number of shares deliverable (contract size) is something other than 100 shares of stock and/or it includes cash-in-lieu, it's sometimes very difficult to determine how much the option is in the money or out of the money.

Here's a formula for determining this value, which should help you make sense of the quoted option price for our example, XYZ1 10/20/2012 33.00 C:

In-the-money/out-of-the-money amount = {[(underlying stock price No. 1 × number of shares deliverable) + (underlying stock price No. 2 × number of shares deliverable) + cash-in-lieu] - (strike price x multiplier)} ÷ multiplier

XYZ = $27.45
ZYX = $46.65
Cash-in-lieu = $10.00

ITM/OOTM amount = {[27.45 × 100) + (46.65 × 33) + 10.00] - (33.00 × 100)} ÷ 100

ITM/OOTM amount = {[(2745.00) + (1539.45) + 10.00] - (3300)} ÷ 100
ITM/OOTM amount = 994.45 ÷ 100

ITM/OOTM amount = 9.94 (in the money, since the result is positive)

Knowing that this option is 9.94 in the money helps explain why the bid is 7.70 and the asking price is 12.30. This is especially true when you compare it to the standard 33.00 calls, which are out-of-the-money with an asking price of .03 since there are only 3 days until expiration.

Next Steps

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