By now you’ve probably heard that two of the highest-flying stocks, Apple, Inc. (Symbol AAPL) and Tesla (Symbol TSLA), have announced stock splits. There have been many articles about the splits and what it means for holders of the stock, but not much has been written about what will happen to the holders of the option contracts. Not to worry, that is what we’re here for! We’ve got all the important dates involved with the spilt, we’ll explain how the option contracts will be adjusted, and even address some of the pitfalls that may occur when you find yourself in an adjusted option contract position right here.
Apple is a little more seasoned in splitting their stock, while Tesla is new to the game, with this being their first stock split since going public. The official announcement from Apple came on July 30th, when the company announced a 4-for-1 split of Apple common stock with plans for the stock to begin trading on a split adjusted basis on August 31, 2020. Tesla made a similar 5-for-1 split announcement on August 11 — also to begin trading on a split adjusted basis on August 31st.
This will be Apple’s fifth stock split since the company went public back in December 1980. The first three times, Apple split its stock on a 2-for-1 basis. The first split was on June 16, 1987, the second on June 21, 2000, and the third on February 18, 2005. The most recent stock split was on a 7-for-1 basis on June 9, 2014.
Important Dates Involved With the Split
The Record Date: This date determines which shareholders are entitled to receive additional shares due to the split. For every share owned on the record date, new additional shares of stock are issued. If you sell the stock after that date and before the stock split occurs, you will not be eligible to take part in the split.
Apple: August 24, 2020
Tesla: August 21, 2020
The Split Date: The shareholders on record are due the additional split shares after the close of business on this date.
Apple: August 28, 2020
Tesla: August 28, 2020
The Ex-Date: The date determined by NASDAQ when Apple and Tesla common shares will trade at the new split-adjusted price.
Apple: August 31, 2020
Tesla: August 31, 2020
What happens to Apple Options contracts because of the split?
Directly from the Options Clearing Corporation (OCC) information circular, it says “Pursuant to Article VI, Section 11A, of OCC’s By-Laws,” all outstanding AAPL option series will be adjusted to reflect this 4-for-1 common stock split. The OCC will issue three additional contracts for each open contract on the ex-date. Also on the ex-date, each AAPL series will have an adjusted exercise price equal to one-fourth of the exercise price rounded to the nearest 1/100th of a point for each AAPL series existing on the business day immediately prior to the ex-date.
In layman’s terms, it means if an option trader currently has one AAPL option contract in his/her account, the investor will keep that contract and will be given three more to make the total four contracts. But the exercise price, often referred to as the strike price, of all the contracts in the position will be divided by four and rounded off. Which means the trader may have a decimal in the strike price of the option contracts. Also, the price of the option contact will be a quarter of the price before the split. Obviously, the price of the option will also depend on where Apple’s stock price is after the split.
For example, let’s say Chantel has in her account five AAPL October 16th 510 Strike Call option contracts that closed on Friday, August 28th at $26.90. On the morning of Monday, August 31st, when she looks in her account, she will see 20 AAPL October 16th 127.50 Strike Call options, and the price of the option should be about $6.73, give or take, depending on the market conditions at the time.
Math involved for the Apple 4-for-1 split:
- Contracts: 5 x 4 = 20
- Strike price: 510 / 4 = 127.50
- Price of the options: 26.90 / 4 = 6.725
A Quick Example of What Happens to a Tesla Option Contract Position
Next, let’s look at a Tesla position. Say Chantel has in her account three October 16th 2000 Strike Call option contracts that closed on Friday, August 28th at $259.20. On the morning of Monday, August 31st, when she looks in her account, she will see 15 AAPL October 16th 400 Strike Call options, and the price of the option should be about $51.84, give or take, depending on the market conditions at the time.
To run the same analysis on the Tesla 5-for-1 split, the math would look like this:
- Contracts: 3 x 5 = 15
- Strike price: 2000 / 5 = 400
- Price of the options: $259.20 / 5 = $51.84
Possible Pitfalls of Having an Adjusted Option Position
After a stock goes through a split, it can create many different strikes in each available expiration, which is going to be the case in each of these splits. Also, the exchanges reserve the right to open additional “standard” strike prices. I bring this up because it can cause a liquidity issue. Liquidity in the market means there are active buyers and sellers at all times, with heavy competition to fill transactions. This activity drives the bid and ask prices of stocks and options closer together.
After Apple and Tesla’s splits, there will be some contracts with “odd” fractional strike prices. The exchange will still make markets for them, but they will most likely open additional strikes that do not have decimals. If you think about it, if you did not have a position in AAPL or TSLA options before the split, which open contract would you most likely want to trade, the ones with the fractional strike prices or the ones without? Most investors would flock to the contracts with even strike prices (no fractions). This diversion of the volume to the more “standard” strikes (or even priced) may make these particular options less liquid, which, over time, could increase the width of the bid/ask spreads on the adjusted contracts. A wider bid/ask spread implies that an order may be harder to fill at a “decent” price, and this could eat into your profitability or add to your loss in the end.
It’s a factor to keep in mind. It may be prudent to do the math ahead of time and see where your strike price is going to fall.
As senior options analyst for Ally Invest, Brian Overby is a widely sought-after resource for his option trading knowledge and market insights. He has contributed to numerous articles for the Wall Street Journal, Reuters, and Bloomberg, and has had frequent appearances on CNBC Fast Money and Fox Business News. A veteran of the financial industry since 1992, Brian continually seeks to improve the understanding of the retail investor. He has given thousands of option trading seminars worldwide, written hundreds of articles on investing, and is the author of the popular trading resource The Options Playbook and its free, acclaimed companion site OptionsPlaybook.com. Prior to Ally, Brian was a senior staff instructor for the Chicago Board Options Exchange (CBOE) and managed the training department for one of the world’s largest market makers, Knight Trading Group.