Corporate Action Adjustments to Options

Corporate actions like stock splits, mergers, and special dividends can significantly alter the terms of existing option contracts. The Options Clearing Corporation (OCC) adjusts contracts to maintain economic equivalence, but these adjustments create non-standard options with unique characteristics.

Definition and Key Concepts

What Triggers Adjustments

The OCC adjusts option contracts for:

• Stock splits (forward and reverse)
• Stock dividends (typically 10% or more)
• Special cash dividends (above ordinary dividend threshold)
• Mergers and acquisitions
• Spinoffs and restructurings
• Rights offerings

Regular quarterly dividends generally don't trigger adjustments—option pricing already incorporates expected dividends.

Types of Adjustments

Adjusted Option Identifiers

Adjusted options receive modified symbols:

• Root symbol often gains a number suffix (e.g., AAPL1, AAPL2)
• Different series from the same adjustment may have different suffixes
• The OCC publishes information memos detailing each adjustment

How It Works in Practice

Stock Split Adjustments

Forward Split (2-for-1): Before: 1 contract = 100 shares at $200 strike After: 2 contracts = 100 shares each at $100 strike

Your number of contracts doubles; each new contract has half the strike price. Total exposure remains the same.

Complex Split (3-for-2): Before: 1 contract = 100 shares at $150 strike After: 1 contract = 150 shares at $100 strike

The deliverable becomes 150 shares, creating a non-standard contract. New standard options are listed with 100-share deliverables at post-split prices.

Special Dividend Adjustments

Large cash dividends (typically $0.125 or more, or 10%+ of stock price) trigger strike price reductions.

Example:

• Stock: $50
• Special dividend: $5.00
• Original $50 call strike → Adjusted $45 strike
• Deliverable remains 100 shares

This maintains the call's moneyness relative to the adjusted stock price.

Merger Adjustments

Mergers create various outcomes depending on deal structure:

All-Cash Deal:

• Options become deliverable for cash equal to merger price
• Exercise yields fixed cash amount
• Trading continues until expiration or exercise

Stock-for-Stock Deal:

• Options deliver shares of acquiring company based on exchange ratio
• Strike remains the same
• Deliverable changes (e.g., 0.75 shares of Acquirer per old share = 75 shares per contract)

Mixed Deals:

• Combination of cash and stock
• Complex deliverables requiring careful review of OCC memo

Worked Example

Scenario: 3-for-1 Stock Split

Before Split:

• ABC stock: $300
• You hold 2 contracts of ABC $320 calls
• Delta: 0.45
• Premium: $18.00 per contract

OCC Adjustment:

After the 3-for-1 split:

• ABC stock: $100
• Your position: 6 contracts of ABC $106.67 calls
• Deliverable: 100 shares per contract (standard)
• New strike: $320 ÷ 3 = $106.67

The fractional strike ($106.67) is unusual but preserves economic equivalence.

Scenario: Special Dividend

XYZ trades at $80 and declares a $10 special dividend.

Before Adjustment:

• You hold 1 XYZ $85 put
• Put is $5 OTM
• Premium: $2.50

After Adjustment:

• Stock: $70 (after dividend)
• Your position: 1 XYZ $75 put ($85 - $10 adjustment)
• Put is still $5 OTM relative to adjusted price
• Premium: ~$2.50 (approximately unchanged)

Without the adjustment, your OTM put would suddenly be $15 ITM—an unintended windfall. The strike adjustment maintains relative moneyness.

Risks, Limitations, and Tradeoffs

Liquidity in Adjusted Options

Adjusted options often have poor liquidity:

• Wide bid-ask spreads
• Low open interest (only existing holders remain)
• Difficult to exit positions at fair value

New standard options are listed post-adjustment and attract most trading activity. Consider closing adjusted positions and reopening in standard contracts if liquidity is needed.

Confusion with Standard Options

Adjusted options with the same strike price as new standard options can cause confusion. Verify you're trading the correct series:

• Check the root symbol for adjustment suffixes
• Confirm deliverable shares (100 vs. non-standard)
• Review OCC adjustment memos when in doubt

Complex Deliverables

Non-standard deliverables create complications:

• 150 shares per contract breaks standard position sizing
• Cash-plus-stock combinations require tracking multiple components
• Odd-lot situations may arise at exercise

Tax Basis Tracking

Adjustments affect tax basis calculations:

• Split adjustments divide basis across new contracts
• Merger adjustments may trigger gain/loss recognition or carryover
• Special dividend adjustments reduce strike but may not affect basis uniformly

Maintain detailed records and consult IRS guidance for specific situations.

Common Pitfalls

1. Trading the wrong series: Adjusted options and new standard options coexist. Verify deliverables before trading.

2. Ignoring liquidity costs: Wide spreads on adjusted options can consume significant value.

3. Missing OCC announcements: Adjustments are detailed in OCC information memos. Read them for specifics.

4. Assuming automatic equivalence: While adjustments aim for economic neutrality, pricing nuances may differ.

5. Overlooking exercise implications: Exercising options with non-standard deliverables creates unusual share quantities.

Checklist for Corporate Action Preparedness

• Monitor corporate action announcements for your holdings
• Review OCC information memos for adjustment details
• Understand new deliverable terms (shares, cash, or combination)
• Assess liquidity in adjusted contracts vs. new standard options
• Calculate position value before and after to verify equivalence
• Update trading systems to reflect new symbols and terms
• Consider closing positions pre-adjustment if liquidity is paramount
• Document tax basis changes from adjustments

Next Steps

With corporate action adjustments understood, explore how fundamental factors drive option premiums. See Basic Option Pricing Drivers for the key inputs that determine option value.

For background on exercise and settlement that applies to adjusted contracts, review Assignment, Exercise, and Expiration Logistics.