Stock splits are not rare, they happen quite often.
In this article, I'm going to try to shed some light on what happens to options when stock is doing a reverse split.
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On March 24, 2020, I bought both call and put ratio back spread options on XOP ETF.
A couple of days later I was reading on SeekingAlpha that XOP is doing a reverse stock split (4:1)
My first question was - what happens to my options now I'm currently holding on XOP ETF.
In today's article, I will try to find answers on two questions - what is a reverse stock split? and what happens to options hold while stock is doing a reverse split?
Reverse stock split for XOP 4:1
- In the past month, XES has declined 67% to $2.13 per share and XOP has fallen 57% to $7.54 per share.
- Both ETFs will trade at their post-reverse split price-effective March 30, 2020.
I made a comment on that article:
And what happens to options then?
I currently hold May 15 expiry ratio back spreads on XOP
but no reply yet. Ah, okay, this is fine.
So I started to search more
Reverse Stock Split
A reverse stock split is a type of corporate action which consolidates the number of existing shares of stock into fewer, proportionally more valuable, shares. The process involves a company reducing the total number of its outstanding shares in the open market, and often signals a company in distress. A reverse stock split divides the existing total quantity of shares by a number such as five or ten, which would then be called a 1-for-5 or 1-for-10 reverse split, respectively. A reverse stock split is also known as a stock consolidation, stock merge or share rollback and is the opposite exercise of stock split, where a share is divided (split) into multiple parts.
Good, now when we know what a reverse stock split is, let's try to figure it our what happens to options during a split.
Options Reverse Split
A reverse split also reverses the adjustment process. For example, if you buy a call option that controls 100 shares of XYZ with a strike price of $5. If XYZ announces a 1:5 stock split, the contract would now control 20 shares with a strike price of $25.
Example with XOP
As in my case XOP is doing a 1:4 stock split, and I hold the following contracts:
call ratio back spread before
- sold 1 call 8 @1.20 (mul=100)
- bought 2 calls 10 @0.45 (mul=100)
call ratio back spread after
- sold 1 call 32 @1.20 (mul=25)
- bought 2 calls 40 @0.45 (mul=25)
put ratio back spread before
- sold 1 put 8 @1.29 (mul=100)
- bought 2 puts 6 @0.55 (mul=100)
put ratio back spread after
- sold 1 put 32 @1.29 (mul=25)
- bought 2 puts 24 @0.55 (mul=25)