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Stock Splits Can Cause Panic: Relax, All is Well

You write a covered call on a stock trading at $165.00 and sell the $170.00 call option. A few days later, your stock is trading at $28.00 and the strike you sold no longer appears on option chains. What do we do? Panic? Curl up into the fetal position and feel sorry for ourselves? Research the matter and respond in a non-emotional manner? So much for the rhetorical questions.

In August 2017, TAL Education Group (NYSE: TAL) was a stock listed on our Premium Member Stock Report at a price of $165.60. On August 16th the listed price was $28.00. The strike prices for options associated with this security were also much lower than they had been prior to the 16th. The first explanatory event that should come to mind is a stock split.

 

TAL Education Group- 6-for-1 stock split

 

covered call writing and stock splits

TAL: 6-for-1 Stock Split Contract Adjustments

By speaking with our brokers, checking CBOE.com/contract adjustments or simply googling “TAL/stock split” we will access the information highlighted in the screenshot above:

  • TAL underwent a 6-for-1 stock split on 8/16/2017
  • For every 1 share owned, the holder now owns 6 shares
  • Share price is reduced to 1/6 its previous value resulting in no change in total value
  • Strike prices are also divided by 6 so the $75.00 strike becomes a $12.50 strike
  • Had we sold 1 $170.00 call option, that will change to 6 contracts of the $28.33 strike

The key takeaway is that there is no change in value of our total position, either positive or negative. Stock splits are maneuvers by Boards of Directors to lower share price and allow retail investors the opportunities to purchase shares in 100 share increments. Another example is when Apple Computer was trading over $700.00 per share and then split 7-for-1 (where are you Google and Amazon?).

 

TAL updated option chain

 

stock splits and covered call writing

TAL Post-Split Option Chain

 

Had we sold the $170.00 pre-split call, the new option chain will show the $28.33 ($170.00/6) strike with a bid-ask spread of $1.15 – $1.35. These are now the prices we refer to when managing our new positions (we now are responsible for six times the number of short contracts).

 

Discussion

All trading and investment strategies must be managed non-emotionally. When share price drops dramatically and strike prices disappear from option chains, the first event that should come to mind is a stock split that will result in contract adjustments. These corporate events will not add to or detract from our portfolio value but rather must be managed from a new perspective. Panic and fear should have no place in our position management arsenal.

 

Why show stocks with inadequate open interest in our premium reports?

This is a question that has come up quite a bit lately. The reasons are:

  • Open interest can change after the report was produced
  • We have many members that use these reports for buying and selling stocks without the option component and so open interest is not a factor 

Below is a screenshot of where open interest is located in our member reports (Y means more then 100 contracts and N means less than 100 contracts for near-the-money strikes):

covered call writing and option liquidity

Open Interest and the BCI Premium Stock Reports

 

Upcoming speaking events

POINT, or Phoenix Options Investors Networking Traders,

March 2 @ 6:30 pm9:00 pm 

Friday March 2, 2018 6:30 PM to 9:00 PM   Rio Salado Community College 2323 West 14th Street · Tempe, AZ

Find out more »

American Association of Individual Investors: Phoenix Chapter

March 3 @ 9:00 am12:00 pm
 

Saturday, March 3, 2017 9:00 AM    Registration/Social Time 9:00 AM    Refreshments Time 9:30 AM    Program Time Location: Jewish Community Center 12701 N. Scottsdale Road Scottsdale, Arizona 85245 DIRECTIONS: The Center is 3.66 miles south of 101 on Scottsdale Road. The Center is on the left as you drive south from 101 OR Take 101 to E. Cactus. Drive 2 miles west on E. Cactus to N. Scottsdale Rd. Turn right on N. Scottsdale Rd. The Center is 1/8 mile on…

 

Portfolio Overwriting webinar for The Options Industry Council (OIC)

Date: 3/22 @ 2 PM ET

FREE Registration Link:

https://event.on24.com/wcc/r/1601761/6C464B87CD0C7A4ADA711D117EED7372?partnerref=presenter

 

Market tone

 This week’s economic news of importance:

  • Manufacturing PMI Feb 55.9 (55.4 expected)
  • Services PMI 55.9 (53.8 expected)
  • Existing home sales Jan 5.38 million (5.61 expected)
  • FOMC minutes Jan 31st
  • Weekly jobless claims Feb 17 222,000 (229,00 expected)
  • Bloomberg consumer confidence 56.6 (last 57.0)

For the week, the S&P 500 rose by 0.55% for a year-to-date return of  2.76%%

Summary

IBD: Market in confirmed uptrend

GMI: 3/6- Buy signal since market close of February 20, 2018

BCI: Market volatility (VIX) has dipped under 20, a positive. If this trend continues, I plan to take more aggressive stances on my positions. Currently, I hold an equal number of in-the-money and out-of-the-money strikes and remain fully invested.  

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

The 6-month charts point to a neutral outlook. In the past six months, the S&P 500 was up 14% while the VIX (16.49) moved up by 39%.

Wishing you much success,

Alan 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.

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5 Responses to “Stock Splits Can Cause Panic: Relax, All is Well”

  1. Duminda February 24, 2018 4:11 am #

    Alan,

    Regarding the IBD 8-10% guideline, if the share price has fallen 8-10% due to, say, panic selling in the market (i.e. a non-company specific event), do we still buy back the options at any price and sell the shares as per this guideline of 8-10% or do we roll down to an OTM strike to mitigate our loss in the hope that market will rally?

    Thanks,
    Duminda

    • Alan Ellman February 24, 2018 8:42 am #

      Duminda,

      In the scenarios when most shares decline due to overall market decline or “panic-selling”, we always buy back the option using the 20/10% guidelines. At that point, we roll down to out-of-the-money strikes to begin the process of mitigating losses. The process of option-selling continues to lower our cost basis.

      Exceptions to this guideline would be when we have market aberrations like we last experienced in 2008 when we may opt to close all positions until the market recovers. These occasions are extremely rare.

      Alan

  2. Jay February 24, 2018 4:53 pm #

    Hey Alan,

    If we had to put titles on our blog posts this one would be “Suspicions of a Cynical Hobbyist” 🙂

    Does it seem to you or anyone else that the computer programs are running the market to an ever increasing degree?

    Most days this week before yesterday they ran the market up in the morning and down in the afternoon for a negative close on light volume. I suspect that may have created an increase in short interest which they saw yesterday so they ran the market up a bit, that caused short cover buying and we had a great up day on half the average daily volume on SPY, less than average volume on DIA and only a slight volume uptick on QQQ.

    Conventional wisdom suggests a meaningful breakout is when a resistance level is breached on high volume. That is not what happened yesterday. It looked to me like a computer generated short squeeze. And now that many shorts bought back to close at a loss to the house the machines will take their profits early in the week with much less short exposure to pay when they take the market back down?

    If you are paranoid like me you only have to be right once :)!. Just curious if you, Barry or anyone else suspects the same thing and if mine is a reasonable assessment? – Jay

  3. Barry B February 24, 2018 10:55 pm #

    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 02/23/18.

    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

    barry@thebluecollarinvestor.com

  4. Marsha February 25, 2018 8:21 am #

    I am re-reading the exit strategy chapters in the Complete Encyclopedias and was wondering if you ever roll up in the same contract month? All the examples are for rolling out and up to the next month.

    Thank you.

    Marsha

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