Contract adjustments to the terms of our covered call writing and put-selling options are due to corporate actions like mergers and acquisitions, special dividends and stock splits. This article will highlight the contract alterations resulting from a reverse stock split.
What is a reverse stock split?
This is a reduction in the number of a corporation’s outstanding shares and a corresponding increase in the value of those shares. This results in making the shares look more attractive to institutional investors who may have minimum price requirements and also may address exchange de-listing concerns due to low prices. These actions are made by the underlying companies while the corresponding adjustments to option contracts are made by the Options Clearing Corporation Securities Committee.
Option symbology components: INTC200619C00065000
- INTC: Option ticker symbol
- 200619: Expiration date- June 19, 2020
- C: Call option
- 00065000: $65.00 strike price
Contract definitions
Multiplier: The number used to calculate total premium, generally 100. If a premium is listed at $2.00 with a standard multiplier, the cost to buy the option is $200.00
Deliverable: Defines the unit of trade (stock, cash) that changes hands on exercise. It is usually 100 shares of stock.
Types of contract adjustments for reverse stock splits
- Deliverables are decreased
- Option symbol changes
- A new class of options is listed after the split using standard terms
Adjustments are NOT made for the following components
- Number of contracts in account
- Strike prices
- Multiplier (still 100)
Real-life example with Alerian MLP ETF NYSE: AMLP)
AMLP Price Chart 2019 – 2020
From February through March, the price of AMPL declined from $42.00 to $12.00 (post-split prices) triggering the company’s decision to institute a 1-for-5 reverse stock split.
Options Clearing Corporation Announcement of AMLP’s 1-for-5 reverse stock split
AMLP 1-for-5 reverse stock split announcement
Note the following:
- For each share owned, .20 shares will be owned post-split effective 5/18/2020 (deliverables change)
- Stock symbol temporarily changes from AMLP to AMLP2D (ticker symbol changes)
New option-chains reflect the price increasing fivefold with ensuing standard contracts
AMLP Option-Chain
The post-split option-chain shows near-the-money strikes in the $20s which means pre-split, the prices would have been in the $5.00 – $5.50 range.
Discussion
Reverse stocks splits are generally initiated when share price substantially declines. The value of the stock remains unchanged but companies feel that they will benefit from this cosmetic enhancement. The components of option contracts that are adjusted are the ticker symbol and number of shares delivered.
Your generous testimonials
Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:
Alan,
Thank you so much for your feedback. It really makes the difference when the person who teaches you a technique is also there to bring you some assistance.
I really like your service. It’s highly rich and educates for a reasonable fee!
Best regards,
Gaetan (from Belgium)
Upcoming events
1. Michigan AAII Chapter webinar
Trading in a Low Interest-Rate Environment
Creating a 3-income stream strategy
Wednesday June 24th
7 PM
Login information to be sent to registered members (club and premium members)
2. Greensboro North Carolina AAII Chapter webinar
Covered Call Writing to Generate Monthly Cash-Flow
Option Basics and Practical Application
Saturday June 20, 2020
10 AM
Login information to be sent to registered members (club and premium members)
This presentation will include the basics of trading option, an overview of covered call writing and 4 practical applications of the strategy.
***********************************************************************************************************************
Market tone data is now located on page 1 of our premium member stock reports and page 8 of our mid-week ETF reports.
*******************************************************************************************************************
Alan,
Thank you for another excellent article. My question is do contract adjustments have any advantage for buyers or sellers of options? For calls or puts?
Thanks,
Marsha
Marsha,
One of the mission statement for the Options Clearing Corporation (OCC) is to make sure that nobody realizes gains or losses resulting from contract adjustments.
Both buyers and sellers of both calls and puts remain “whole” after the contract adjustments.
Understanding how these contract adjustment impact our positions will dictate how we move forward with trade management.
If we don’t fully understand the changes, I suggest contacting your broker or the OCC itself for an explanation. Here is a link:
https://www.theocc.com/webapps/infomemos?query=contract+adjustments&submit-search.x=10&submit-search.y=8
Alan
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 05/29/20.
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
Since we are still in Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:
https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/
Best,
Barry and The Blue Collar Investor Team
[email protected]
Hi Alan…
sold ZM & CRWD jun 19 calls last month
ZM 160 @ $10.80….now $$27.00
CRWD also jun 19 $4.20 and now @ $32.45
what is smart play here? of course (blowout) earnings on tues for both.
Thx John
John,
When a strike moves deep in-the-money (ITM), the first exit strategy that comes to mind is the “mid-contract unwind” exit strategy. Use the “Unwind Now” tab of the Elite version of the Ellman Calculator to determine the time-value cost-to-close. With deep ITM strikes, the time-value usually approaches zero but because both companies are due to report earnings on Tuesday June 2nd, the IV may still result in a high cost-to-close.
If we decide to close both legs of the trade, we use the cash to enter a new covered call position with a different stock. If this is the path we choose, we must take action tomorrow June 1st to avoid the risk of the earnings report.
Other choices include:
Taking no action
Closing the short call in expectation of a favorable report (risky)
Buying a protective put
Give consideration to the BCI rule of never selling an option when there is an upcoming earnings report prior to contract expiration. If we love the company and have confidence in earnings results, we can own the stock through the report and then sell the option after the report passes. In most cases, we avoid these stocks until post-earnings.
The good news is that at this point in time the trade results are maximized with plenty of downside protection.
Alan
Allan.
Please clarify
:
If I have sold a covered call, can I also put a stop order sale limit on stock(I sold calls for) to protect if stock prices start falling?
Thanks
Philip
My experience is that if you attempt to place a stop limit on the stock while having an open position on the call, the trading platform will not allow the stop limit. You have to buy back the call first. Give it a try, you will find out.
This will work if you have a margin account
Philip,
Covered call writing requires the lowest level of trading approval because of the low-risk nature of the strategy. When a covered call trade is changed by selling a stock first, it becomes a much riskier “naked” option position which requires a higher level of trading approval. Most retail investors will not be approved for naked option trading. This is actually a positive in my view.
The best approach is to set a buy-to-close limit order on the short call. If executed, we can make a decision on the next step which may or may not be to sell the stock. Using the 20%/10% guidelines will assist in protecting us when share price declines.
Alan
Alan:
Many thanks for suggestion.
I had also bought selling cash secured put, book and found this book to be very informative. Thanks a lot.
Philip
Houston, we may have a problem..
There are 2 stocks symbols REGN (Regeneron Pharmaceuticals)) and RGEN (Repligen Corp.).
Looks like REGN moved from failed list correctly to the current run list (5/29/20) (moved from 5 to 6 weeks on run list).
RGEN was listed in last weeks run list (5/22/20) at 18 weeks on run list and it looks like if failed this week’s run list (5/29/20). Problem: It is not listed in the failed run list.
Do you agree?
MarioG
Mario,
Good catch…thank you. RGEN did, in fact, fail this week and placed in the red section. The problem was that I use a number of columns that are not part of the report for the many sorts that I do during the report compilation process. In the case of RGEN, I didn’t make an entry in one of those columns.
The reason RGEN failed this week was due to not passing the MACD and Slow Stochastics screens on RGEN’s price chart.
Best,
Barry
Great. Have to keep that report perfect. I thought I was seeing double when I saw REGN at a price of over 600 per share and I could not find RGEN anyplace.
Great memorable launch of SpaceX with spacecraft Endeavour here in Florida on Saturday with 2 astronauts. Reminded me of John Glenn’s flight on February 20, 1962 in spacecraft Friendship 7 on top of an Atlas F rocket. I saw the launch while cooping with the University of Florida at Cape Canaveral and working with NASA in the Aeromedical Instrumentation Section at Hangar S – 58 years ago. The flight lasted only 5 hours (3 orbits) and there was some excitement with the rentry and a loose heat shield. It was my second day on the job.
Mario
I sold an IWM CC at 140 for expiration Friday May 29th. IWM closed Friday at 138.90 yet the call was exercised even though OTM. Any idea why this would happen?
Best;
Terry
Terry,
I can think of 2 possibilities:
1. Market-makers have about 90 minutes after the market closes to decide whether to exercise their option positions. If news comes out, after 4 PM ET and before 5:30 PM ET, that changes the view of the “moneyness” of the option on Monday morning, exercise may occur for this, now, out-of-the-money strike. I could find no reason for this possibility for IWM in this case.
2.Investor error. The exercise notice is sent to a broker, then to the OCC and then randomly to a broker and then randomly to one of its clients ..could be us.
The shares can be repurchased today. As of 5 AM ET, it appears the cost will be lower than the $140.00 per share you received.
Alan
Hi Alan,
In the hypothetical covered call trade below, I own 100 shares of QQQ at $230 and sold a $234 strike call, expiring May 29.
If the price does not reach $234 by closing bell Friday, the short call will expire worthless and I will still own the stock but will lose out on about $3 of potential share appreciation.
If I wanted to capture that $3 in share appreciation, on expiration Friday at 10-15 minutes before market close, could I buy back the short call (.07) in this example, and then sell the stock at market or about $233, and capture $3 in share appreciation, that I would otherwise forfeit if I took no action and let the call expire worthless?
Thanks,
Dave
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Dave,
QQQ closed on Friday at $233.36. The difference between taking no action and buying back the short call and selling the stock is that in the former, the gain is unrealized and, in the latter, the gain is realized.
In both cases, shares are worth $233.36.
Alan
Premium Members,
The Weekly Report for this week, 05/29/20, has been revised and updated. Please look for the report dated 05/29/20-RevA
The reason for the revision was the deletion of RGEN from the “Passed Previous Weeks & Failed Current Week”. RGEN has been added back into this section. There wasn’t any impact on the stocks that passed this week.
Best,
Barry
Two questions:
1) What happens when the split would result in fractional shares in the contract e.g. 3:2 or 6:1?
2) Are there any liquidity issues with the new options? Someone buying an option is unlikely to buy these new non-standard options and instead buy the standard 100 share ones (post reverse split). Isn’t there likely to be a wide bid-ask spread?
David,
Excellent questions:
1. Prices are round to the nearest fraction of a penny. Here is a link to an article I [previously published showing such pricing:
https://www.thebluecollarinvestor.com/covered-call-writing-and-contract-adjustments-our-premium-report-is-getting-even-better/
2. Open interest (OI) initially remains the same because the open contracts just transfer over to the adjusted contracts. However, as a result of most investors preferring standard contracts, as open contracts are closed, there are fewer opened so OI will drop. Also, many brokerages will only allow closing adjusted contracts which will also decrease OI.
A summary of adjusted contracts is that supply and demand decreases resulting in wider bid-ask spreads.
Alan
Alan,
I am thinking of taking options positions in Shen (ticker symbol). With recent acquisition of Sprint, T-Mobile is on the 90 day clock to negotiate purchase of the company. It is high probably they will purchase the company. Should I take potions in call options to capture the profit opportunity?
I believe the stock will rally when they merger is announced. I’m looking at the 60 and 55 strike price respectively for Oct 16. What are the downsides of this trade? I have done some preliminary research on options when companies merge. Is this a good strategy?
Demetrius
Hey Demetrius,
Playing mergers is always risky which is what makes it lucrative when it works! But buying calls leaves you wide open to time decay as well as being wrong.
I don’t know anything about this deal or how the stocks involved trade. That may make my thoughts more objective? If you are bullish the deal pick a target strike and time frame you like then also sell a call above that to reduce your cost (and possible profit) making it a bullish debit spread where time decay will be reduced. Since you are bullish you can further reduce your trade cost and time decay by selling a cash secured put underneath your strike price of the bought call. If the whole thing goes to crap you may have the csp assigned and the bought call spread expire worthless.
So it really depends on the confidence you have in the transaction and what you are willing to risk if wrong? If you are Gung Ho on it the bought calls upside is infinite and the risk limited to what you pay. But you are talking about an instrument that time decays fast unless you get it right. So I would at least pair it with some form of sold option to slow that down. My two cents, – Jay
Hey Alan,
Are you mostly in cash or now fully in the market? Also, are you still recommending in the money strikes?
Thanks
Clark
Clark,
I remain 50% in cash but slightly more bullish by selling a mix of ITM and OTM strikes on better-performing stocks and ETFs. So, short-term defensive and longer-term bullish mainly because of the historically low interest rates.
Alan
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 as well as the implied volatility of all eligible candidates.
Also included is the mid-week market tone at the end of the report.
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
Alan:
I need one more guidance from you.
I have 1000 stock of SLB, old cost being 54.00, total 54000, Present stock price around 18, how this position can be fixed by option? Is bull call spread can fix it?
Can you indicate few examples for fixing?
Thank you.
Philip
Philip,
When we buy a stock which subsequently declines in value substantially, we must focus in on what’s important. Do we care about the stock itself or the cash we have invested in it? We now have $18k, not $54k. Where is that $18k best placed? In SLB or another stock? If it’s in the original stock, we write OTM calls generating premium + allowing for share appreciation:
https://www.thebluecollarinvestor.com/covered-call-writing-managing-stocks-that-have-gapped-down/
We do not put more capital into the position. If we decide the original stock is no longer an elite-performer, we sell, realize a loss and place the remaining capital in a better-performer. $18k feels awful but $10k would feel worse. The decision requires careful assessment of the underlying stock.
There are situations when we can use the stock repair strategy to lower our breakeven:
https://www.thebluecollarinvestor.com/stock-repair-strategy-using-stock-options-to-reduce-losses-when-stock-price-declines/
BCI has developed a Stock Repair Calculator to assist with this strategy:
https://thebluecollarinvestor.com/minimembership/stock-repair-calculator/
Alan
Alan:
I am interested in putting in trailing stop orders for my stocks, but it seems to me that if I do that, I would not be able to write covered calls because the stock could get sold and I would still have a pending call without the stock. Can I do both?
Thanks,
Larry
Larry,
If the stock is sold prior to closing the short call, we find ourselves in a naked options position… very risky. Most of us cannot get trading approval for this which is a much higher level of approval than covered call writing.
The best way to manage these situations (share price declines) is to set a buy-to-close limit order on the short call immediately after the covered call trade is entered. In the BCI methodology, we use 20%/10% thresholds.
Many brokerages offer notification services when a trade is executed. If the short call is closed (bought back), we then decide our next step which may or may not be to sell the stock.
Some brokerages offer OTO choices where the execution of one trade automatically triggers the execution of another trade. My preference is to have the ability to decide on the next step if the short call is closed.
Alan