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Reverse Splits and Unreliable Options Chains

Stock splits are corporate events where the number of shares in circulation changes as well as the price -per-share. If we own 100 shares at $50.00 per share pre-split and the stock splits 2-for-1, then we will own 200 shares at $25.00 post-split. The value of our position ($5000.00) does not change.

 

What is a reverse stock split?

This is a reduction in the number of corporate shares along with a corresponding increase in share value. In the above example, a 1-for-2 reverse stock split would result in owning 50 shares at $100.00 per share, still a $5000.00 total value.

 

Why would a company promote a reverse stock split?

There are several reasons this would make sense, none of which would encourage us to own the stock or exchange-traded fund (ETF).

  • From a cosmetic standpoint, the increase in stock price makes the company appear more formidable and successful
  • Certain exchanges require a minimum price or the stock can be de-listed
  • Institutional investors tend to avoid lower priced securities

 

Real life example: UVXY

The chart below tells us everything we need to know why this ETF twice opted for a reverse stock split:

reverse stock splits

UVXY Declining Price Chart

On July 12, 2016, as share value has plummeted to $7.00 per share UVXY announced a 1-for-5 reverse stock split. The effective date for this split was 7/25/2016. Share price on the 25th was about $6.00 per share so for every 100 shares owned pre-split, 20 shares at $30.00 would be the new position post-split. The position value does not change at the time of the split but $30.00 is more cosmetically pleasing than is $6.00.

 

How does a reverse split impact our options?

There is no one formula that will apply to every scenario so we must research these contract adjustments. Here are related free resources:

  • www.cboe.com
  • www.theocc.com
  • Ask your broker to research for you (the first two are better choices in my view)

Let’s view the changes in this specific example:

Option symbol

UVXY changes to UVXY2

Shares deliverable per contract

100 shares become 20 shares

Price-per-share

UVXY2 = 0.20 (UVXY) or 1/5 the market price

Multiplier (amount option price changes in total value for a 1.00 change)

The multiplier remains 100 so if option price changes by “1” total contract value changes by $100.00

Non-adjusted contracts

In addition to the newly adjusted contracts (UVXY2), the exchanges begin introducing non-adjusted contracts based on the new market pricing. This creates a scenario wherein some contracts deliver 100 shares while others deliver 20 shares (I’m even getting a headache from this… however, in the interest of education we push on.

 

Unreliable option chains

When adjusted contracts exist along with standard contracts (100 deliverable), there should be some sort of indication as to which is which. In this case, adding that “2” to contract symbols with an explanatory footnote would do the trick. However, that’s not always the case. In the screenshot below, the options chain shows a $3.00 strike trading between $2.88 – $3.25 for a stock trading at $21.74.  For standard contracts, that is impossible as there is at least $18.74 in intrinsic value. That’s how we know that this is an adjusted contract.

contract adjustments following reverse stock splits

UVXY Options Chain Showing $3.00 Strike

Further down this very same options chain, we see a non-adjusted $20.00 contract with a bid-ask spread we would expect for a stock price $1.74 in-the-money and expiration coming up in a few hours:

UVXY Options Chain Showing Non-Adjusted $20.00 Strike

UVXY Options Chain Showing Non-Adjusted $20.00 Strike

 

Discussion

Reverse stock splits are generally corporate maneuvers designed to give the appearance of safe, secure and reliable investments. These events will result in contract adjustments for our options and these changes do not always fit one specific formula. It is important to understand the implications of these changes and to carefully view options chains that may not discern between adjusted and non-adjusted contracts. Asking ourselves if the premium amount makes sense for a standard contract will get us to the correct understanding of the contract type.

**************************************************************

For more information on stock splits:

Complete Encyclopedia- Classic: pages 323 – 332

Complete Encyclopedia- Volume 2: pages 299 – 308

More ***************************************************************

 

Upcoming live events

1- January 26, 2017

9 PM ET

Blue Hour webinar #4

“The Poor Man’s Covered Call”

Free to premium members

We will analyze the use of LEAPS options instead of buying stocks to enter a covered call trade at a much lower capital outlay

This is a must-see presentation

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More information to follow

 

Market tone   

Global stocks declined slightly this week while US indices remained flat. The Dow Jones Industrial Average approached the psychologically significant 20,000 mark before consolidating. Crude oil lost about 75 cents on the week, ending around $52.50, while the Chicago Board Options Exchange Volatility Index (VIX) remains historically low, at 11.44. This week’s reports and international news of importance:

  • Already strong US gross domestic product figures were revised higher in the final reading for the third quarter. Originally reported at 3.3%, the economy actually grew 3.5%, according to an estimate by the US Bureau of Economic Analysis
  • Q4 growth looks to be somewhat less impressive with estimates in the 2.0% to 2.5% range
  • In the United Kingdom, Q3 growth was also revised higher. On a quarter-over-quarter basis, the UK economy expanded 0.6% in the three months following the Brexit vote, up from an earlier 0.5% estimate
  • Italy’s government has authorized a bailout of that country’s third-largest lender, Monte dei Paschi di Siena, after the bank failed to raise sufficient capital in the financial markets to stay afloat. Monte dei Paschi has been in operation since 1742
  • If the United Kingdom does not remain a member of the European Union’s single market, Scotland will hold another referendum on withdrawing from it, according to Scottish first minister Nicola Sturgeon
  • The Bank of Japan upgraded its economic assessment, noting that a moderate recovery trend had continued while exports had picked up. Improved foreign demand was credited with the export boost, along with a weaker yen, which should help solidify the recovery, the bank said
  • Deutsche Bank and Credit Suisse each agreed to settle outstanding cases with the US Department of Justice involving the selling of mortgage-backed securities dating back to the global financial crisis

THE WEEK AHEAD

  • Japan releases consumer price and unemployment data on Monday, December 26th
  • Japan reports retail sales data on Wednesday, December 28th
  • US November pending home sales figures are released on Wednesday, December 28th

For the week, the S&P 500 declined by 0.07% for a year-to-date return of +10.47%. 

Summary 

IBD: Market in confirmed uptrend

GMI: 5/6- Buy signal since market close of November 10, 2016

BCI: I am currently fully invested and have an equal number of in-the-money and out-of-the-money strikes.

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a bullish outlook. In the past six months, the S&P 500 was up 6% while the VIX (11.44) declined by 35%.

_____________________________________________________

Wishing you the best in investing and a wonderful holiday season,

Alan ([email protected]) and the BCI team

 

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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.

17 Responses to “Reverse Splits and Unreliable Options Chains”

  1. Jordan December 24, 2016 5:21 am #

    Alan,

    Is there a service or website that provide a list of stocks that will be splitting or reverse-splitting?

    Thank you and Merry Christmas.

    Jordan

    • Alan Ellman December 24, 2016 7:38 am #

      Jordan,

      Yes. A free site for locating stock splits is found on Yahoo Finance. Here’s the direct link:

      https://biz.yahoo.com/c/s.html

      Happy holidays to one and all.

      Alan

  2. Alan Ellman December 24, 2016 11:13 am #

    Premium members:

    The server for the member site is being replaced with a larger server. The member site will be down for a short time this morning and perhaps into the afternoon. My team is working to minimize the down time for this enhancement.

    Alan

    • Alan Ellman December 24, 2016 11:34 am #

      Up and running quicker then anticipated…Alan

  3. Barry B December 25, 2016 1:25 am #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 12/23/16.

    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 link to the BCI YouTube Channel is:

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

    Best,

    Barry and The Blue Collar Investor Team

  4. John December 27, 2016 1:07 pm #

    Alan,

    Last Monday I bought 500 shares of nvda at 100.50 and sold 5 january 105 contracts for 2.50. Today the stock is trading for 116.58 and it would cost 13.50 to buy back my options. Is this a good move or is it too early to buy back these options?

    Thank you.

    John

    • Alan Ellman December 27, 2016 3:58 pm #

      John,

      The strategy you are considering is known as the mid-contract unwind exit strategy in my books/DVDs. It will be a viable strategy when the cost-to-close is less than the profits we can generate by closing and opening a completely new position. There are several ways to calculate the cost-to-close and the “unwind now” tab of the Elite version of the Ellman calculator will do all the math for us. As an exercise, let’s calculate the long way:

      Unrealized current results:

      Share appreciation = $105.00 -$101.50 = $4.50

      Option credit = $2.50

      Total unrealized profit = $7.00

      $7.00/$100.50 = 7%

      Now let’s calculate if we close (commissions left out):

      Share appreciation = $116.58 – $100.,50 = $16.08

      Option debit = $13.50 – $2.50 = $11.00

      Net credit = $5.08

      $5.08/$100.50 = 5.1%

      The net cost-to-close is 1.9% (7% – 5.1%)

      A case can be made for both perspectives but in my view, it’s too expensive to close and a 7%, 1-month return with huge downside protection is much too tempting to take off the table for an opportunity to beat a 1.9% return in the remaining weeks to expiration. I would take no action but more aggressive investors may look to generate even higher returns.

      Alan

      • Mario Guerrero December 29, 2016 5:03 am #

        Alan,

        Commenting on John’s Blog article where he bought 500 shares of nvda at 100.50 and sold 5 january 105 contracts for 2.50. Today the stock is trading for 116.58 and it would cost 13.50 to buy back my options.ell NVDA.

        I have found a quick way of calculating for a roll or other BTC transactions is to use the BEP Break Even Point as a reference point to make the math calculations and comparisons quick on paper.
        A. Profit if assigned in the money (Sell price : 105)
        BEP = 100.50 -2.50 = 98
        Profit $105 – 98 = $7
        Return ROO% 7/100.50 = 7.0

        B. Buy back when price = 116.58 and Option to close is 113.50
        BEP = 100.50 -2.50 +113.50 = $111.50
        Profit = 116.58 -111.50 = $5.08
        Return ROO% 5.08/100.50 = 5.1%

        C. Comparison 7% -5.1% = 1.9% loss if do the BTC.

        Regards,

        Mario

  5. Alan Ellman December 28, 2016 9:34 am #

    Personal experiences and trading tips:

    One of our members, Mario, has shared these real-life experiences and trading ideas:

    Some tips from actual trading experiences.

    Tip1: Reminding users to maintain cash reserve to cover a Required Minimum Distribution:

    Just thought it might be a good tip for future years to remind your membership near the November Expiration Friday that 2-4 % cash reserve will not be enough cash reserve to cover your Required Minimum Distribution for the year if you are in an IRA account.

    Most retirees have it paid out in December. I had one scheduled for Dec. 15 and lucky I bought back a trade on Dec. 14 and it bounced back saying I did not have enough cash. Fidelity was able to cancel the transaction that same day. Otherwise I would not have enough cash to make a buy back and would had an option exercised for Expiration Friday 12/16.
    .*****

    Tip2: Resolving a problem with an accidental Covered call STO trade to the wrong account when you have both a Retirement and Non-Retirement account with the same broker.

    I have two accounts with Fidelity, one a Retirement and another an IRA. I strive to keep 4% reserve for buy backs in both sometimes it is larger. I had a case where I needed to use up my cash to reduce the reserve by $5000. My default was the Non-retirement account.

    I placed a Covered Call STO trade around 3:55pm. When I went to document my portfolio cash later in my Yahoo and Excel Spreadsheet portfolios I noticed the Fidelity account had less than $200 cash balance. That meant I could not use any exit strategies later!

    Well, Fidelity resolved the matter by making an internal processing transaction to move the funds to the Retirement account. Problem solved. This might be a policy with all brokerage houses as a customer service.

    This happened to me one other time but in that case I had to unwind another position so it was a non-issue.
    .*****

    Tip3: Watching out for those Option chains with a Bid of 0 and a Mark premium with 1/2 the Bid to Ask price and how your broker might be able to help for a bad trade.

    Months ago, in my early option trading days I did check off on my Trade Analysis sheet when writing a call that the OI (>100) and Spread (<$0.30) was satisfied. At my Optionshouse account, they have a column called MARK which is the average of the bid and ask. Fidelity now includes this in their option chains as well now. What happened is that in one trade I was careless and did not check off the Spread was ok and placed a trade at the mark value of a Bid and Ask of 0 and 2.00 (Average = $1.00) and traded Covered call STO at the “Market” I found out that I had an Income of $0.01. Just after the close of the day I called Optionshouse and the trader said that I was taken advantage of and said he might be able to help me out somehow by contacting a buyer or market trader (I assume). Later I received a notice that my account was adjusted to give me $100 income which I did not complain about. Was pleased with the resolution. For Tip 3 case (Bid 0 and Ask $2.00): Just want to add I only make LIMIT option grades (as Alan recommends on pages 216 and 225 of Classic Encyclopedia) and to play the spread. The only exception is if I have to make a quick trade after trying to satisfy a limit price which keeps changing because of changing underlying price activity. Thanks to Mario for sharing these experiences and trading tips with our BCI community. Alan

  6. Alan Ellman December 28, 2016 10:40 am #

    Blue Chip Stocks in the news: Goldman Sachs

    GS has been on an impressive price run since the beginning of August. As a matter of fact, the entire financial sector, including banks and broker-dealers, have been on a tear since the election. Despite the run up in price, GS still trades at a forward PE under 16, below market average. This stock has had 4 consecutive earnings :”beats” and has only one “miss” in the past 5 years.

    Our 1st quarter, 2017 Blue Chip Report shows that in the past 3 months, GS has increased in price by 43% compared to the S&P 500 which is up 6%. In the past one year, GS has appreciated by 35% while the S&P has moved up by 11%.

    The chart below shows a moving average crossover in the beginning of August that has resulted in a price increase of nearly $90.00 per share.

    CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG

    Alan

  7. Alan Ellman December 28, 2016 5:04 pm #

    Premium members:

    This week’s 8-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:

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

    NOT A PREMIUM MEMBER? Check out this link:

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

    Alan and the BCI team

  8. Steve December 29, 2016 10:04 am #

    Do you look at the probabilities otm to decide which option to choose when writing or do you simply go with your % of return that you would like?
    thx steve

    • Alan Ellman December 29, 2016 3:02 pm #

      Steve,

      The probability of a strike expiring in-the-money is definitely not my main focus. I first decide on the “moneyness” of the strike (ITM, ATM OTM) based on chart technicals, overall market assessment and personal risk tolerance. From there, I check the option chains to see which strikes meet my personal monthly goals (2-4% for initial returns). The overall concept is to generate monthly cash flow (or Weekly in some cases) and to put ourselves in the best position for success. Once that trade is entered, we now focus in on position management opportunities.

      Alan

  9. Alan December 29, 2016 12:22 pm #

    Alan,

    I come from a background in forex and trading complex options such as Iron Condors, Iron butterfly and credit, debit spreads. In trading such options I would never even get close to the expiration time, taking %50 profit for small gains.

    Writing covered calls one of the reasons i liked the strategy was the idea of letting the Call get assigned, a kinda hands off approach if things go well and saving money on option fees. I have a small account just over 15,000 so fees are a big deal to me.

    I use TD Ameritrade and i discovered that they charge a huge $19.99 fee for assignment! I did not realize this, and even your pdf on broker fees doesn’t show this. I’m upset because TD Ameritrade is one of the highest commission out there $9.99 a trade .75 contract.

    Should i change brokers or is this 19.99 fee something i should just deal with and not ever get a assigned? or try to not get assigned.

    What do your members and you yourself recommend in a broker for covered call writing?

    Thank you for your time

    Alan.

    • Alan Ellman December 29, 2016 3:19 pm #

      Alan,

      We should never tailor our strategy around broker commissions but rather select a strategy that meets our goals and then select an appropriate broker for that strategy.

      I do not like an exercise fee higher than the usual commission to sell a stock…I agree with you here. There are 2 paths to consider:

      1- Call your contact at TD Ameritrade and ask for a reduction in exercise fee. Explain (they already know this) that other brokerages simply charge a standard trade commission. They may not comply but you never know…it’s worth asking.

      2- Find another broker. Our broker file is a good start and has all the contact information. Many of our members use Interactive Brokers because of their very low commissions but they may have other requirements that may not meet your goals…again worth asking. There are several choices on the list with reasonable commissions.

      Alan

      • Alan Ellman December 30, 2016 1:58 pm #

        Just received this email from Alan B:

        Hey Alan!

        you not going to believe this but I called TD Ameritrade like you suggested.

        I explained to them that there assignment fee was the highest in the market,

        $9.99 stock trade and .75 contract with assignment fee of $19.99

        right away he put in the paperwork to get stock to 8.95 and assignment fee crushed to $8.95!!! I should here back from them Tuesday. I think they feel like they better hold on to people wile they got them.

        Please feel free to use my example on how to deal with crazy fees, thank you for your help.

        truly
        Alan

        • Jay December 31, 2016 12:25 pm #

          Way to go Alan B.!

          Another suggestion I had success with is if you do move an account to one of the better discount on line brokers and then sometime down the road you see they offering an attractive offer to new accounts they were not offering when you joined call them up.point out you are a loyal customer and got no such offer.

          I opened a substantial – for me anyway – account with Options House a few years ago. Subsequently I saw they were offering 100 free trades to those funding new accounts. I called them up, said I never got that, they looked at my account and grand-fathered me into the offer.

          The on-line brokerage business is fiercely competitive. There is no reason in the world to settle for a fee structure until you have shopped it around and are comfortable with. – Jay

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