Definition
The term adjustment refers to a change in an option contract precipitated by certain actions taken by a corporation. Adjustments to the terms of an option contract may include its strike price, deliverable, expiration date as well as multiplier.
Explanation
When an investor buys or sells an option, the contract will include a number of variables such as the option's strike price, the stock involved in the transaction, the expiration date, as well as a multiplier. An adjustment to the contract can occur following certain actions by the corporation issuing the stock.
Note: All contract adjustments are governed by the Options Clearing Corporation's (OCC) By-Laws and Rules.
Example
Stock splits and mergers provide the best examples of corporate actions that may warrant a change in the terms of an option contract. For example, if a 2-for-1 stock split is announced, the adjusted option will now include 200 shares of stock. When this occurs, the premium is multiplied by the new factor, which in this case is 200 shares. If the investor were to purchase one call at $2.00, the cost would be $2.00 x 200 shares, or $400.
Related Terms
The term assignment refers to a notification by the Options Clearing Corporation that the owner of an option exercised their rights. Assignments for equity and index options are made on a random basis.
Moneyzine EditorJanuary 8th, 2024
The term cash-backed call refers to the strategy of setting aside enough money in an interest-bearing account to exercise a call option purchased by the investor. Cash-backed calls allow the investor to purchase a stock at the lower of the call's strike price or market.Moneyzine EditorNovember 6th, 2024
The term bull call spread refers to a vertical spread consisting of two calls with the same expiration date but different strike prices. Bull call spreads produce a near term cash outflow in exchange for a possible longer-term cash inflow.Moneyzine EditorNovember 6th, 2024
