Publicly traded companies may decide to split their stock for various reasons. If a company's stock price has gone up, the price may be too high for investors to purchase shares. A stock split lowers the price of shares making them more attractive
A stock split means that existing shareholders receive additional shares, but the value of the shares will not increase due to the stock split. When a stock split is announced, an options contract undergoes an adjustment called "being made whole," which adjusts the terms of the contract so that the value does not change.
Key Takeaways
- A stock split means that existing shareholders will receive additional shares, but the value of the shares will not increase at the time of the split.
- Similarly, a stock splitwill increase the total number of shares outstanding but willnotincrease the market capitalization of a company.
- A stock split announcement means that an options contract undergoes an adjustment called "being made whole."
What Is a Stock Split?
"Being made whole"means the options contract is modifiedso that the holder is neither negatively nor positively affected by the corporate action. While a stock split adjuststhe price of an option'sunderlying security, the contractis adjusted so that any changes in price due to the split do not affect the value of the option.
Ifyour option is purchased post-split (that is, after the split is announced),itwill not be adjusted because it already reflects the post-split price of the underlying security. TheOptions Clearing Corporation will automatically make these adjustments for the sake of orderly and smoothfunctioningmarkets.
Stock Split Calculations
If a company with 20 million shares announces a 2-for-1 stock split, shareholders receive one additional share of stock for each share they already own. The company's total number of shares outstanding is now 40 million. Because of the split, the value of each share is halved. A share that was worth $16 before the split will now be worth $8.
A stock split will not increase the value of each share, but each stockholder will receive additional shares.
The "being made whole" calculation is relatively straightforward for options. Each option contract typicallycontrols100 shares of an underlying security at a predetermined strike price. The new share ownership isgenerated by taking the split ratioand multiplying it by 100 while the new strike price is generated by takingthe old strike price and dividingit by the split ratio.
For example, if you buya calloption that controls100 shares of XYZ with a strike price of $75. If XYZ announces a 2:1 stock split, the contractwould now control200 shares with a strike price of $37.50. On the other hand, if the stock split is 3 for 2, the option would control150 shares with a strike price of $50.
Stock Split vs. Reverse Split
A reverse split also reverses the adjustment process but in a different way. A reverse split or reverse stock split announcement means that the number of existing shares of stock are consolidated into fewer, higher-priced shares.
The existing total quantity of shares is divided by a number such as five or 10, which would then be called a 1-for-5 or 1-for-10 reverse split, respectively. A reverse split is also known as a stock merge and is the opposite of a stock split, where a share is divided into multiple parts.
Stock Splits and Market Capitalization
While a stock splitincreases the total number of shares outstanding, it willnotincrease the market capitalization of a company—the total market value of its shares. Thus, a company with 20 million shares outstanding at $20 per share has a market capitalization of $400 million.
A 2-for-1 stock split means that both the stock and its price are halved, and the total market value of the company's stock remains the same (40 million shares at $10 per share is $400 million).
Is a Split Good for a Stock?
Yes, generally a split is good for a stock. While the value of the company's stock does not change, a stock split typically makes a stock more affordable for some investors who may not have been able to afford the shares before. This increases interest in the stock and oftentimes leads to increased investor demand. A stock split is considered a bullish move.
What Is a Stock Split?
A stock split is when a company decides to split one share into multiple shares. This increases the total shares outstanding for existing investors but does not affect the value of the stock. For example, if a company had a share price of $100 and decided to split one share into two shares, an investor that had one share of the stock at $100 would now have two shares of the stock at $50 each.
Is a Stock Split a Good Time to Buy?
A stock split does not mean that a company's financial profile has changed and that it is now a better investment. A stock split simply means that the share price is now lower and there are more shares outstanding. If a company was a bad investment before a stock split, it would still be a bad investment. If it were a good investment before the split, it would still be a good investment, and now may be more affordable to some investors due to the reduced share price.
The Bottom Line
Stock splits are a common occurrence in company shares. They help reduce the price of a share to make it more affordable for investors. The total value of your shares does not change. Similarly, with an option on a stock, the option is adjusted so that the value does not change.
FAQs
Bottom line on options and stock splits
What happens to your stock when it splits? ›
A stock split lowers its stock price but doesn't weaken its value to current shareholders. It increases the number of shares and might entice would-be buyers to make a purchase. The total value of the stock shares remains unchanged because you still own the same value of shares, even if the number of shares increases.
What happens after a stock split quizlet? ›
You know that after a split, which increases the number of shares outstanding, the market price per share will be reduced. With a 5:4 stock split, the new price should be about 4/5 the old price. A 1/5-change equals 20% (100% / 5 = 20%).
What happens to options when stock spin off? ›
If you own options on a stock that executes a spinoff, the new options contract ticker will have a number added to it. The expiration date on your contract won't change. Keep in mind, you won't be able to see this new ticker in the app unless you owned the option before the corporate action.
What happens to a short position when a stock splits? ›
Stock splits do not affect short sellers in a material way. There are some changes that occur as the result of a split that can impact the short position. However, they don't affect the value of the short position. The biggest change that happens in the portfolio is the number of shares shorted and the price per share.
How do stocks react to stock splits? ›
In fact, the company's market capitalization, equal to shares outstanding multiplied by the price per share, isn't affected by a stock split. If the number of shares increases, the share price will decrease by a proportional amount. If a stock traded at $100 previously, it will trade at $50 after a 2-for-1 split.
What happens when a stock splits 3 to 1? ›
The overall value of their investment will stay mostly unchanged. They'll own three times as many shares but each share will be worth roughly one-third of what it used to be worth, evening everything out. This doesn't necessarily mean that Walmart's 3-for-1 stock split is entirely irrelevant for investors.
What two things happen when a stock splits two for one? ›
Let's look at a common scenario, which is a 2-for-1 split: Investors receive one additional share for each share they already own. The stock price is halved—$50 becomes $25, for example—and the number of shares outstanding doubles.
What happens after a stock split more than one answer may be correct? ›
After a stock split, existing stockholders receive additional shares of stock in ratios such as 2:1 or 3:1 or 4:1 (as some common examples). After a stock split, the Common Stock caption of stockholders' equity indicates a drop in the par value per share (if appropriate).
What is stock split quizlet? ›
Traditional stock split. A split where the value of a share and the number of shares are changed in such a proportional way that the value decreases as the number of shares increases, while the market cap remains the same.
When your company (the "Target") merges into the buyer under state law, which is the usual acquisition form, it inherits the Target's contractual obligations. Those obligations include vested options. Therefore, your vested options should remain intact in a merger/reorganization scenario.
Why do options go down when stock goes up? ›
Stock traders don't have to worry about time value because they can own a stock for years. But options have a finite life that ends at expiration. So the stock price must rise higher than your strike price before time decay eats away the value of your option.
Do I lose stock options if laid off? ›
If you worked for a pre-IPO startup and earned incentive stock options (ISOs) or non-qualified stock options (NSOs), you have a limited amount of time — in many cases, just 90 days after getting laid off — to decide whether you want to buy your stock options or forfeit them back to the company.
Should I buy before or after a stock split? ›
Do stock splits benefit investors? – It's nice to own more shares after a split, since the reduced per-share price might mean there's room for greater potential price growth. But investors shouldn't buy a stock simply because they hope it'll rise in price after a split.
Do stocks rebound after a split? ›
One common belief that investors have regarding stock splits is that a stock's price will go up after a split, but splits do not guarantee that a stock's value will go up. Investors should do additional research and look at the stock's overall financial health.
Should I sell before a reverse stock split? ›
Selling before a reverse stock split is a good idea, but selling after the reverse stock split is not. Since you can sell before and after a reverse stock split, selling during one is optional. The main advantage of selling before the reverse stock split is that you don't have to wait around for it to happen.
Do I make money if my stock splits? ›
Stock splits: What you need to know. A stock split doesn't change the value of your investment. If you own the stock of a company that executes a stock split, the details of your position change, but the total value of your position does not. Here are the key things to know about stock splits.
Do stocks normally go up after a split? ›
Splitting the stock brings the share price down to a more attractive level. The actual value of the company doesn't change but the lower stock price may affect the way the stock is perceived and this can entice new investors.
Is it better to buy stock before or after a split? ›
Do stock splits benefit investors? – It's nice to own more shares after a split, since the reduced per-share price might mean there's room for greater potential price growth. But investors shouldn't buy a stock simply because they hope it'll rise in price after a split.
Do stocks do well after a split? ›
While a split, in theory, should have no effect on a stock's price, it often results in renewed investor interest, which can have a positive effect on the stock price. While this effect may wane over time, stock splits by blue-chip companies are a bullish signal for investors.
