Listed companies may decide to split their shares for various reasons. If a company's stock price has risen, the price may be too high for investors to buy shares. Astock splitlowers the price of stocks, making them more attractive
A stock split means that existing shareholders will receive additional shares, but the value of the shares will not increase as a result of the stock split. When a stock split is announced, an option contract undergoes an adjustment called “being made whole,” which adjusts the terms of the contract so that its value does not change.
Key learning points
- A stock split means that existing shareholders will receive additional shares, but the value of the shares will not increase at the time of the split.
- Likewise, a stock split will increase the total number of shares outstanding, but not the market value of a company.
- A stock split notice means that an option contract undergoes an adjustment called "making whole."
What is a stock split?
'Reinstated' means that the option contract is amended in such a way that the holder is neither negatively nor positively affected by the corporate action. While a stock split adjusts the price of an option's underlying asset, the contract is adjusted so that any price changes resulting from the split do not affect the value of the option.
If your option was purchased post-split (i.e. after the split was announced), it will not be adjusted because it already reflects the post-split price of the underlying security. ThatOpties Clearing Corporationwill make these adjustments automatically in the interest of orderly and well-functioning markets.
Stock split calculations
If a company with 20 million shares announces a 2-for-1 stock split, shareholders will receive one additional share of stock for each share they already own. The total number of the companyshares excellentnow amounts to 40 million. The split halves the value of each share. A stock that was worth $16 before the split will now be worth $8.
A stock split will not increase the value of each share, but each shareholder will receive additional shares.
The "becomes whole" calculation is relatively simple for options. Each options contract typically controls 100 shares of an underlying security at a predetermined valueexercise price. The new stock ownership is generated by taking the split ratio and multiplying it by 100, while the new strike price is generated by taking the old strike price and dividing it by the split ratio.
For example, if you buy a call option that controls 100 shares of XYZ with a strike price of $75. If XYZ announces a 2:1 stock split, the contract will now control 200 shares with a strike price of $37.50. On the other hand, if the stock split is 3 for 2, the option would control 150 shares with a strike price of $50.
Stock split vs. reverse distribution
INreverse distributionalso reverses the adaptation process, but in a different way. An announcement of a reverse split or reverse stock split means consolidating the number of existing shares at fewer, higher prices.
The existing total number of shares is divided by a number such as five or 10, which would then be called a 1-for-5 or 1-for-10 reverse split, respectively. A reverse split is also called a stock merger and is the opposite of a stock split, where one share is divided into several parts.
Stock splits and market value
Although a stock split increases the total number of shares outstanding, this will not happenmarket valueof a company - the total market value of its shares. For example, a company with 20 million shares outstanding at USD 20 each could have a market capitalization of USD 400 million.
A 2-for-1 stock split means that both the stock and its price are halved, and the total market value of the company's shares remains the same (40 million shares at $10 per share is $400 million).
Is a split good for a stock?
Yes, in general a split is good for a stock. Although the value of the company's stock does not change, a stock split usually makes a stock more affordable for some investors who may not have been able to afford the stock before. This increases interest in the stock and often leads to greater demand from investors. A stock split is considered a bullish move.
What is a stock split?
A stock split occurs when a company decides to split one share into multiple shares. This increases the total number of shares outstanding for existing investors, but does not affect the value of the shares. For example, if a company had a stock price of $100 and decided to split a share into two shares, an investor who had one share of $100 would now have two shares of $50 each.
Is a stock split a good time to buy?
A stock split does not mean that a company's financial profile has changed and that it is now a better investment. A stock split simply means that the stock price is now lower and there are more shares outstanding. If a company was a bad investment before the stock split, it would still be a bad investment. If it had been a good investment before the split, it would still be a good investment, and now it may be more affordable for some investors due to the lower share price.
In short
Stock splits are common in company shares. They help lower the price of a stock to make it more affordable for investors. The total value of your shares does not change. The same applies to an option on a share: the option is adjusted so that its value does not change.
