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When Strike Prices Disappear: Contract Adjustments

Stock options are contracts with terms that can change prior to expiration. Mergers, acquisitions, special dividends and stock splits are some of the events that may necessitate the change in terms. Since early September, New Orient Edu&Tech (EDU) has been on the Blue Collar Premium Stock List. In the middle of September I received several emails from members wondering what happened to the strike prices they sold. Several members had sold the $21 call options and wanted to buy them back prior to expiration but they no longer existed…They were gone!

EDU had issued a 1-time special cash dividend of $0.35 per share with an ex-dividend date (date you must own the shares to capture that dividend) of September 4th and payable on October 7th. Here is the information gleaned from the CBOE site (www.cboe.com):

Covered call writing and contract adjustments

EDU: contract adjustment

 

The dividend would be earned by all who held ownership in the shares on September, 2013. Whenever a dividend is distributed the price of the stock will decrease by the amount of that dividend because the company will have that much less cash and therefore be worth less. In order to make buyers and sellers of calls and puts “whole” after the price change, adjustments are made in the contract terms. In this case the strike prices were adjusted down by the dividend amount as shown below:

Covered call writing and special 1-time dividends

EDU: strike price changes

 

The row highlighted in yellow shows the change in the $21 strike price to $20.65. As covered call writers, although the price of our shares will technically decline in value, we will, in fact, capture the dividend on October 7th to make us “whole”

To retain ownership of the shares and to roll the option, a covered call writer would then buy back the $20.65 and re-sell that or another next month strike. The chart below shows the short-term price dip around the time frame of the ex-dividend date and the performance of this equity since that time:

Special 1-time cash dividends

EDU price chart showing price dip around the time of the ex-date

 

The price dip was partially due to the special dividend.

 

Conclusion:

When we see that a strike price we had previously sold no longer exists, it is usually due to an event that caused the Options Clearing Corporation (OCC) to change the terms of that option. The changes are made to make investors on both sides of that trade “whole” The best action to take is to call your broker or check the CBOE site or a similar one to learn the new parameters of the contract.

Beat the rate increase for Premium Membership: LAST FEW DAYS TO LOCK IN LOWEST RATES:

On January 17th, 2014 we will be raising subscription rates for both monthly and annual memberships. Current members will be grandfathered in to the current lower rates and need to take no action to retain this lower fee schedule. All new members who subscribe prior to January 17th will also be grandfathered in to the lower rates. Thanks for the positive feedback we have received for the new and enhanced version of our Premium Stock reports. Link to subscribe:

http://www.thebluecollarinvestor.com/membership/

 

Next live speaking engagement:

Houston, Texas;

Tuesday, January 14th

6:30 – 8:30

http://www.aaii.com/chapters/meeting?mtg=2576&ChapterID=12

 

Market tone:

A very confusing jobs report culminated a week of mixed economic reports:

  • According to the Labor Department, 74,000 jobs were added in December, below the 197,000 expected and less than the 241,000 added in November
  • Despite this disappointment, the unemployment rate dropped to 6.7%, below the 7.0% expected. The reason for these positive and negative signals has to do with the fact that many Americans are no longer looking for work and have dropped out of the work force. The 6.7% stat is a 5-year low
  • Consumer credit [a report of the dollar value of consumer debt, including categories such as credit card use and store charge accounts (known as revolving debt) as well as longer-term loans for autos, education, recreation vehicles, etc. (known as non-revolving debt). The level of consumer credit is considered a barometer of consumers’ financial health and an indicator of potential spending patterns] rose by $12.3 billion in November, although credit card debt increased by a meager $500 million
  •  Orders for manufactured goods rose by 1.8% in November, turning around the 0.5% decline in October
  • The ISM non-manufacturing index came in at 53.0 below the 56.0 anticipated and at the lowest level since June but still showing expansion
  • The US trade deficit decreased to $34.3 billion in November, the lowest level in 4 years. This was the result of exports increasing by 0.9% while imports decreased by 1.4%. A deficit of $40 billion was projected by analysts
  • Minutes from the Fed’s December meeting showed that the winding down of the quantitative easing program was due to improving economic conditions as well as rising costs
  • Janet Yellen was approved by the Senate to be the next Fed Chair taking over for the outgoing Fed Chair Ben Bernanke

For the week, the S&P 500 rose by 0.6%.

Summary:

 IBD: Confirmed uptrend

BCI: This site retains its long-term bullish stance, currently favoring out-of-the-money strikes 2-to-1.

Much success to all,

Alan (alan@thebluecollarinvestor.com)

www.thebluecollarinvestor.com

 

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

5 Responses to “When Strike Prices Disappear: Contract Adjustments”

  1. Barry B January 12, 2014 1:52 am #

    Premium Members,

    The Weekly Report for 01-10-14 has been uploaded to the Premium Member website and is available for download.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the BCI YouTube Channel link is:

    http://www.youtube.com/user/BlueCollarInvestor

    Best,

    Barry and The BCI Team

  2. Alan Ellman January 12, 2014 3:47 pm #

    Running list stocks in the news: SYNA:

    Synaptics Inc. is a leading innovator in touch technology for PCs, smartphones and notebooks and more recently with fingerprint authentication. Analysts were quite impressed with this company’s innovative elctronics last week at the Consumer Electronics Show in Las Vegas. As a results these analysts have been raising estimates and price targets.

    Our premium watch list shows an industry rank of “A”, a beta of 1.43 with adequate open interest on its options. This company boasts 5 straight quarters of positive earnings surprises as shown on the chart below. CLICK ON CHART TO ENLARGE AND USE THE BACK ARROW TO RETURN TO THIS BLOG:

    Alan

  3. Alan Ellman January 15, 2014 6:28 am #

    Thanks to BCI members:

    For helping me break attendance records at the Houston Chapter of AAII. Many traveled great distances (including from Nebraska!) to attend. Thank you!

    Next up…Orlando.

    I’ll be returning to NY today and will catch up with emails by the weekend or early next week.

    Alan

  4. Alan Ellman January 15, 2014 8:43 am #

    Rate change:

    Thursday January 16th is the last day to register for premium membership and get rates grandfathered into the current lower rates. Monthly membership will change from $29.95 to $39.95 and annual subscriptions will change accordingly. Current members do not need to take any action to get grandfathered into the lower rates.

    Thanks,
    Alan and the BC I team

  5. Alan Ellman January 15, 2014 7:08 pm #

    Premium members:

    This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options.

    For your convenience, here is the link to login to the premium site:

    http://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    http://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

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