Adjustments to Securities

After a stock split or stock dividend, existing options contracts are adjusted to reflect the new share count and price. Certain open orders are adjusted after a forward split, a stock dividend, or a cash dividend, but canceled after a reverse split.

Options Contract Adjustments

The Options Clearing Corporation (OCC) adjusts options contracts for stock splits and stock dividends.

Whole-number forward split adjustments (such as 2-for-1 or 3-for-1), as a general rule:

• Number of contracts increases proportionally
• Strike price decreases proportionally
• The total notional value of the position stays the same

A split such as 3-for-2, and a reverse split, usually change the shares each contract delivers instead of the number of contracts.

Example: 2-for-1 split

• Before: 1 call option with a $80 strike (controlling 100 shares)
• After: 2 call options with $40 strikes (each controlling 100 shares)
• Total exposure: 200 shares at $40 = same $8,000 notional value

Think of it this way: A forward split is like cutting a pizza into more slices. You have more pieces, each one is smaller, but the total amount of pizza stays the same. The OCC makes sure your options reflect the new slice size.

Exam Tip: Gotchas

• Options adjustments are handled by the OCC, not by the individual broker-dealer. The OCC is the central clearinghouse for all listed options.
• The total notional value of adjusted options positions does not change. A whole-number forward split such as 2-for-1 increases the number of contracts and lowers the strike proportionally, so the economics of the position stay the same.

Open Order Adjustments

FINRA's rule on adjustment of orders puts the duty on the broker-dealer holding the open order, not on the exchange. On the day the stock goes ex (ex-dividend or ex-distribution), the firm adjusts the order before it can execute. Only some open orders qualify:

• Stock split or stock dividend: the price is reduced and the share quantity is increased by the ratio
  • Example: Buy 100 shares at $50 limit becomes buy 200 shares at $25 limit (after a 2:1 split)
  • An order marked "Do Not Increase" keeps its original share quantity
• Cash dividend: the price is reduced by the dividend amount and the share quantity stays the same. An order marked "Do Not Reduce" (DNR) keeps its price, and a cash dividend of less than one cent triggers no adjustment
• Reverse split: every pending order, buy or sell, is canceled
• A split the rule does not adjust for: if the customer's order is a buy stop or sell limit, the firm must promptly notify the customer of the split
• Market orders are not adjusted. They have no price to reduce and execute at the current market price

Think of it this way: The stock's price drops on the ex-date only because of the distribution. The orders that get adjusted are the ones that drop could fill or trigger by accident: a buy limit below the market and a sell stop below the market.

Exam Tip: Gotchas

• The firm holding the order adjusts it, not the exchange. Only buy limit and sell stop (including sell stop limit) orders are adjusted. A buy stop or sell limit order is left as entered, and the customer is notified of a split.
• Market orders are not adjusted because they have no price attached. The exam may ask which order types require adjustment.

What Should You Check on Exam Day?

• Can you explain how the OCC adjusts the number of contracts and strike price after a whole-number forward stock split such as 2-for-1?
• Do you know why the total notional value of an options position stays the same after a split adjustment?
• Can you state which open orders the firm adjusts on the ex-date (buy limit, sell stop) and which it leaves alone (buy stop, sell limit, market)?
• Do you know what happens to open orders after a reverse split, compared to a forward split?