To see some of the basics of how options are re-evaluated when stock splits take place, see the following discussion at TradeKing. However, I like to focus on what brings on a stock split and what kind of opportunities that presents for option traders.
When a company announces a stock split, it typically acts as a tremendous catalyst that causes the underlying asset to garner momentum. With this in mind, it is important to understand the stock split process. In this article we”ll explore the requirements for a stock split as well as the general profile of a company that may decide to announce a split of their stock.
A stock split involves the division of corporate stock by the issuance to existing shareholders of a specified number of new shares, with a corresponding lowering of the market value of each outstanding share. This, of course, is opposed to an actual stock dividend, which is usually a payment by a corporation of its own stock without a change in the market value of the underlying asset.
Before a corporation and its board of directors decide to split, they must have their stock to be in a strong uptrend and also have a comfortable anticipation that the stock will continue the trend. Naturally, the company must have enough unissued authorized shares to split the stock, and then the board of directors must then meet and declare a stock split.
If authorized shares need to be added, then the corporation must seek approval from shareholders, which requires a shareholder meeting for a vote to support additional shares being issued. At that point the company can announce the stock split and both the split and recording dates are set. When the split date does indeed arrive, additional shares are issued and the stock price per share is adjusted accordingly.
In addition, a stock split announcement is typically accompanied by another major event. This could be anything like a dividend being paid, expansion plans, a stock buyback program or even changes to management. Usually when a company declares a stock split it means that particular firm is experiencing success.
The average profile of a company that declares a stock split is that they are currently operating with increasing revenue, cash flow and net earnings. Typically, the stock price is close to or higher than the price of the last split, is in a general uptrend and of course is expected to continue to climb. In addition, business is forecast to be very good going forward, shareholder confidence is high and basically no major legal issues are pending reconciliation.
Stock splits are certainly worth monitoring and when correctly identified provide excellent candidates for low risk and high reward options strategies. In fact, if the trader can visualize a stock split coming when implied volatility is currently very low then these particular situations have a tremendous chance of being highly profitable when coupled with the appropriate options strategy. To see how stock splits can be automated and effectively managed for stock option portfolios please click here.
Jeff Neal
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