What Happens to Options While Stock is Doing Reverse Split

| Investments | 105 seen

option trading reverse split

Stock splits are not rare, they happen quite often. 

In this article, I'm going to try to shed some light on what happens to options when stock is doing a reverse split.

Make sure to check out my newsletter: Covered Calls with Reinis Fischer

On March 24, 2020, I bought both call and put ratio back spread options on XOP ETF.

A couple of days later I was reading on SeekingAlpha that XOP is doing a reverse stock split (4:1)

My first question was  - what happens to my options now I'm currently holding on XOP ETF.

In today's article, I will try to find answers on two questions - what is a reverse stock split? and what happens to options hold while stock is doing a reverse split?

XOP Reverse stock split 4:1

Reverse stock split for XOP 4:1

From SeekingAlpha:

  • In the past month, XES has declined 67% to $2.13 per share and XOP has fallen 57% to $7.54 per share.
  • Both ETFs will trade at their post-reverse split price-effective March 30, 2020.

I made a comment on that article:

And what happens to options then?
I currently hold May 15 expiry ratio back spreads on XOP

but no reply yet. Ah, okay, this is fine. 

So I started to search more

Reverse Stock Split

A reverse stock split is a type of corporate action which consolidates the number of existing shares of stock into fewer, proportionally more valuable, shares. The process involves a company reducing the total number of its outstanding shares in the open market, and often signals a company in distress. A reverse stock split divides the existing total quantity of shares by a number such as five or ten, which would then be called a 1-for-5 or 1-for-10 reverse split, respectively. A reverse stock split is also known as a stock consolidation, stock merge or share rollback and is the opposite exercise of stock split, where a share is divided (split) into multiple parts.

Good, now when we know what a reverse stock split is, let's try to figure it our what happens to options during a split.

Options Reverse Split

From: What Happens to an Option When a Stock Splits?

A reverse split also reverses the adjustment process. For example, if you buy a call option that controls 100 shares of XYZ with a strike price of $5. If XYZ announces a 1:5 stock split, the contract would now control 20 shares with a strike price of $25.

Example with XOP

As in my case XOP is doing  a 1:4 stock split, and I hold the following contracts:

call ratio back spread before

  • sold 1 call 8 @1.20 (mul=100)
  • bought 2 calls 10 @0.45 (mul=100)

call ratio back spread after

  • sold 1 call 32 @1.20 (mul=25)
  • bought 2 calls 40 @0.45 (mul=25)

put ratio back spread before

  • sold 1 put 8 @1.29 (mul=100)
  • bought 2 puts 6 @0.55 (mul=100)

put ratio back spread after

  • sold 1 put 32 @1.29 (mul=25)
  • bought 2 puts 24 @0.55 (mul=25)