A:

When the underlying stock of your option splits or even begins issuing a stock dividend, the contract undergoes an adjustment that is often referred to as "being made whole," which means the option contact is modified accordingly so that you are neither negatively nor positively affected by the corporate action. While a stock split will adjust the price of the underlying security of an option, the option is adjusted so that any changes in price due to the split do not affect the value of the option. Keep in mind that if your option is purchased post-split (i.e. after the split is announced) then your option will not be adjusted as it will have been created according to the new split price of the underlying security.

How do you calculate what the new option will be worth? Well, you typically don't need to worry about such things because the Options Clearing Corporation will automatically do it for you (for the sake of orderly and smooth markets). But if you are wondering how it's done, the calculation is relatively straightforward. Each option contract is typically in control of 100 shares of an underlying security at a predetermined strike price. To find the new coverage of the option, take the split ratio and multiply by the old coverage (normally 100 shares). To find the new strike price, take the old strike price and divide by the split ratio. Say, for example, you own a call for 100 shares of XYZ with a strike price of $75. Now, if XYZ had a stock split of 2 for 1, then the option would now be for 200 shares with a strike price of $37.50. If, on the other hand, the stock split was 3 for 2, then the option would be for 150 shares with a strike price of $50.

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RELATED TERMS
  1. Stock Split

    A corporate action in which a company divides its existing shares ...
  2. Split Adjusted

    A modification made to a security's price that takes into consideration ...
  3. Adjusted Exercise Price

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  4. Reverse Stock Split

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  5. At The Money

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  6. In The Money

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