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Post# of 72979
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Market Technician

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Market Technician

Re: Market Technician post# 41304

Saturday, 12/20/2008 6:01:02 PM

Saturday, December 20, 2008 6:01:02 PM

Post# of 72979
What is the effect of stock splits on options? Based on brief reading here and there, it seems that there are positive effects on the underlying shares, which positively affects the option. But, to be honest, I don't see why. Help?

A stock split is nothing more than an adjustment to the company's shares. It adds no real value and is cosmetic in nature. For example, if I own a company and it has 500,000 shares outstanding and each share trades for $100.00, I might decide to split the shares two for one and bring the price down. Bringing the price down might bring more buyers because the stock seems more affordable at $50.00 rather than $100.00.

The market value before the split is $50 million (or 500,000 shares times $100.00 a share). The market value of the company remains $50 million after the stock split. However, rather than having 500,000 shares outstanding, the company has one million shares trading for $50.00 a piece.

The options contracts are also adjusted following a stock split. In most cases, the strike price is adjusted down, but the option owner holds a greater number of contracts. In the previous example, a holder of 10 at-the-money options (or options with a strike price of 100) will become the owner of 20 contracts with a strike price of 50. The adjustments to the options contract following a split can be found in the informational memos at the Options Clearing Corp. (OCC) website, www.optionsclearing.com.

Why do some traders like stock splits if there is no meaningful change to the market value of the company, the shares, or the options contracts? While the reasons vary, many investors and traders believe that stock splits signal favorable trends for the company. For one, the stock price has been trading higher and is climbing in price, so it is in a bullish trend. In addition, management must be confident that the stock price will continue to move higher. After all, management would not split shares of a company when they expect the stock price to decline. Therefore, although stock splits are merely cosmetic in nature, some investors view the split as a positive corporate event that signals good things for the company going forward.

http://www.traders.com

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