Corporate actions such as mergers, acquisitions and spin-offs often necessitate a change to the amount or name of the security deliverable under the terms of the contract. When such adjustments occur, the short call position must deliver the adjusted security at the strike price where the call was sold.
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 .50 shares of Global Giant for every share owned of JKL Inc. 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 own (100 shares per contract x .5 Global Giant). Investors with short positions in JKL call options are then responsible for delivering 50 shares of Global Giant for every call option assigned.
For the sake of this example, we used a simple conversion ratio. However, not all corporate actions have such clearly defined terms. Often assignment requires the short position to deliver fractional shares and a cash equivalent. An adjustment panel consisting of representatives of the listing options exchanges and one OCC representative (who only votes in case of a tie) determine whether to adjust an option because 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, search by company name or symbol in OCC’s Information Memos search.
If a stock fails to maintain minimum standards for price, trading volume and float as prescribed by the options exchange, option trading can cease even before its primary market delists the stock. If that occurs, the exchanges will not add any new series. Trading in existing series may continue on a closing-only basis until they expire. If the primary market suspends trading in the underlying stock before the expiration of outstanding options, the options exchanges may allow closing-only transactions for the options if the underlying begins trading in some capacity (Pink Sheets or OTC). You may want to review OCC’s trading halts policies in Information Memo #30049.
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’s website offers contract adjustment memos with detailed information on how outstanding option contracts will be adjusted due to a corporate action.
- Sign up at the OCC Subscription Center to receive email notifications on contact adjustments
- Quotes – OIC’s website offers a Quotes page where an investor can enter a symbol to obtain all series and strikes available for that option, as well as a description of the option.
- Series Search – OCC’s website offers a Series Search function that displays all strikes. For any adjusted option there will be a numeral following the letters of the option symbol. At that point, one can search for the Infomemo that describes the adjustment.
- Contact [email protected] – 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 entire option string or chain of options to see if pricing appears for call and puts in all strikes. It is highly unlikely that mispriced options exist for an entire option class.
- Two option root symbols share the same strike price. In some cases, an adjusted non-standard contract appears alongside a standard, 100-share contract. When looking at a string of option prices for a particular underlying, check if all the symbols are identical. These contracts, while having the same strike price, but will have different option root symbols. In many cases, the price differences between these two contracts may vary significantly.
No. The adjusted 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 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
- Premium multiplier remains 100
- New deliverable per contract – 10 shares of XYZ Inc.
The value of 10 new shares of XYZ Inc. stock at $6 per share is $60 dollars. The value of the strike price (if exercised) is $500. To determine the point where the post-split stock needs to be for the $5 call to be in-the-money, divide the value of the strike ($500) by the number of shares that underlies the contract (10). This would indicate that the stock must trade above $50 per share for this adjusted contract to be in-the-money.
OCC’s website offers contract adjustment memos with detailed information on how outstanding option contracts will be adjusted due to a corporate action.
Typically, a 1-for-20 reverse split causes 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, a modified option symbol to reflect a change in the deliverable securities.
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. Additionally, trading in the options will cease when the merger becomes effective. As a result, all options on that security that are not in-the-money become worthless and all that are in-the-money have no time value.
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 be short twice as many of the 25 calls.
As explained in Chapter III of the Characteristics and Risks of Standardized Options 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 their firm’s exercise-by-exception thresholds). You may also wish to view Memo #30047 (or the yearly update) regarding accelerated expiration for all-cash-deliverable options.
In the case of an election merger, the option’s deliverable 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 upon exercise after the contract adjustment, they must exercise in advance of the election deadline and submit elections pursuant to the election procedures described in the proxy statement/prospectus.
To view information on option adjustments due to election mergers, visit the Information Memos search on OCC’s website. Please note that all adjustments are determined on a case-by-case basis.
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.”
In all cases, it is the sole responsibility of the person tendering to comply with terms and conditions of an offer.
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. If trading in the underlying stock has been halted, trading on the options will be halted as well. 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. When they do, the options exchanges usually announce that the options are eligible for closing only transactions and prohibit opening positions. 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.
To an option investor, spin-offs are another form of distribution, and can result in contract adjustments as determined by an adjustment panel.
NOTE: When option contracts are adjusted to include the spun-off shares, generally the market prices of stock in both the issuing company and the spun-off company will be reflected in quoted prices for the overlying adjusted option contracts.
Company XYZ announces a spin-off, or a special distribution of new stock in subsidiary Company ZYX to common shareholders of record on a specific date, the record date. The distribution ratio is one (1) new share of ZYX common stock for each share of XYZ currently owned. The primary stock exchange on which XYZ is listed announces a specific ex-date for this spin-off and declares that XYZ common stock will trade with an accompanying due bill from the record date for this distribution until the day before the ex-date. Shares of ZYX common stock will begin trading on a “when-issued” basis under the symbol ZYX WI effective the record date until the ex-date.
Pursuant to OCC rules, an adjustment panel decides to adjust contract terms for options overlying XYZ stock as follows:
|Adjustments for XYZ Spin-Off of ZYX|
|Number of Contracts||unchanged|
|Option Symbol||adjusted to XYZ1|
|Deliverable (Unit of Trade)||100 shares XYZ common stock
100 shares ZYX common stock
|Effective date: declared ex-date for the distribution|
Content Licensed from the Options Industry Council. All Rights Reserved. OIC or its affiliates shall not be responsible for content contained on Company’s Website, or other Company Materials not provided by OIC
Content licensed from the Options Industry Council is intended to educate investors about U.S. exchange-listed options issued by The Options Clearing Corporation, and shall not be construed as furnishing investment advice or being a recommendation, solicitation or offer to buy or sell ant option or any other security. Options involve risk and are not suitable for all investors