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I know very little about Options, but a question I have is.....
I know the writer of the option retains the underlying stock and receives any dividend, but what happens if the stock splits...say 2 for 1 before expiration date.

Can someone enlighten me about this. I wish to buy a LEAP but it is stretched out quite far and I am concerned that with splitting the shares they would be worth half their value, thereby the long expiration date is worthless. How wrong am I?
thanks,
tom
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Hi Tom,

If the stock splits 2-for-1, the strike price of your options will be cut in half. So don't worry.

For example, if you have a LEAP with a strike price of $80, after the split the strike price will be $40. See the following Options Clearing Corporation press release for an example of what happens:

http://www.optionsclearing.com/market/infomemos/2006/nov/22308.pdf


Jim
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If the stock splits 2-for-1, the strike price of your options will be cut in half. So don't worry.

Thanks TMFHamp,
Appreciate the quick reply.

tom
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If the stock splits 2-for-1, the strike price of your options will be cut in half. So don't worry.

For example, if you have a LEAP with a strike price of $80, after the split the strike price will be $40. See the following Options Clearing Corporation press release for an example of what happens:


Its even better than that. If you have 100 shares optioned at $80 strike and the stock splits 2 for 1 you will have 200 shares optioned at $40.

In general, any "distribution" of more than (I think the number is) ~10% of the value of the stock results in an adjustment to the option, and is not lost to the option holder. Adjustments smaller than that, mostly routine dividends, ARE lost to the option holder.

R:
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Hi all,
If I can throw my two cents in, it only comes out rosey when you are in a high volume issue with 2:1. Otherwise, my experience has been that the option becomes very convoluted and volume disappears so your liquidity gets flushed. Don't even let me start on reverse splits!!!
FWIW, Great Trades for All,
David
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<<any "distribution" of more than (I think the number is) ~10% of the value of the stock results in an adjustment to the option, and is not lost to the option holder>>

True, but the Options Clearing Corporation has proposed to replace the 10% rule with a rule based on whether the dividend is special (as opposed to ordinary quarterly distributions) and whether the dividend constitutes at least $12.50 of the option contract's value (i.e., multiplier (usually 100) times per-share dividend must equal at least $12.50). The rule change still requires SEC approval and will only go into effect for dividends announced in February 2009 or later:

http://www.optionsclearing.com/market/infomemos/2006/oct/22210.pdf

<<Adjustments smaller than that, mostly routine dividends, ARE lost to the option holder.>>

I think this assertion needs to be qualified. Granted, the strike price does not change. But the price of the options themselves gradually adjust over the previous few weeks to the impending dividend payment. For example, if 10 days before the ex-div. date the stock goes up $1 and the option normally would go up 50 cents, it may go up only 48 cents because of the impending dividend. It is very possible that the option price will not change at all on the ex-div. date itself because of this gradual adjustment process.

Jim





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