Special Cash Dividends and Equity Distributions: Understanding Contract Adjustments – December 26, 2020
Contract adjustments to the terms of our covered call writing and put-selling options are due to corporate actions like mergers and acquisitions, special dividends and stock splits.
This article will highlight the contract alterations resulting from special dividends and equity distributions.
Special cash dividends: 2 adjustment techniques
1. Ticker remains unchanged
- Number of contracts: Unchanged
- Deliverables: Unchanged (1oo shares)
- Strike price: Reduced by the dividend amount
- Multiplier: Unchanged (remains 100)
Real-life example with Park National Corp. (NYSE: PRK)
A $100.00 strike will be reduced by the special dividend amount of $0.20 to $99.80. The ticker symbol remains PRK.
2. Ticker symbol changes
- Number of contracts: Unchanged
- Deliverables: Adjusted to reflect both share and dividend distribution
- Strike price: Unchanged
- Multiplier: Unchanged (remains 100)
Real-life example with Loral Space & Communications Inc. (NYSE: LORL) (NYSE: PRK)
Each contract will deliver 100 shares of stock plus $550.00. The ticker symbol changes from LORL to LORL1.
Special stock dividends
- Number of contracts: Unchanged
- Deliverables: Increased to reflect the special equity dividend (A 3% dividend will result in a deliverable of 103 shares per contract)
- Strike price: Reduced. Divided by 1 + dividend percent (A 3% dividend will result in all strikes divided by 1.03)
- Multiplier: Increased by the dividend amount (A 3% dividend results in a multiplier of 103
- Option symbol: Adjusted to highlight contract adjustments
Real-life example with Tootsie Roll Industries, Inc. (NYSE: TR)
The ticker symbol changes from TR to TR1 to reflect that adjustments to the option contracts were made due to the corporate action of declaring a stock dividend.
Discussion
There is no single formula for all contract adjustments. But they do fall into certain categories. This article highlights the basic contract adjustments for special cash and equity distributions. When these events occur, we must understand the terms of the adjustment so we can make the most appropriate investment decisions.