Corporate actions rewrite the contract

An option contract specifies what's delivered, normally 100 shares of one stock, at what price. Companies do things that change what those shares are: split them, pay out cash, merge, spin off a subsidiary. When that happens the Options Clearing Corporation adjusts the outstanding contracts so that a holder is in roughly the same economic position after the event as before. The adjustment is fair, mechanical, and easy to misread if you're the one holding it.

Regular dividends: no change

Ordinary cash dividends don't adjust the contract. They're priced into the options in advance, and the stock simply drops by the dividend on the ex-date. The consequence for call sellers is early assignment risk, not an adjustment.

Whole-number splits

A 2-for-1 split on a $100 stock: each contract becomes two contracts, each on 100 shares, with the strike halved. Ten $100 puts become twenty $50 puts. Your economic position is unchanged and the contracts stay standard. 3-for-1 and 4-for-1 work the same way.

Odd splits and reverse splits

A 3-for-2 split doesn't divide into whole contracts, so the deliverable changes instead: each contract now covers 150 shares, and the strike is divided by 1.5. A 1-for-10 reverse split makes each contract deliver 10 shares of the new stock at the old strike. These adjusted contracts are non-standard. They get a new symbol, often with a digit appended, and the exchange lists fresh standard 100-share contracts alongside them. The adjusted series tends to go quiet: wide spreads, little volume, and prices that look wrong until you remember the deliverable isn't 100 shares. Premium that looks fat on an adjusted contract is usually just the multiplier.

Special dividends

A one-time cash payout above a small threshold, in the OCC's practice anything over $12.50 per contract, reduces every strike by the dividend amount. A $5 special dividend turns a $50 put into a $45 put. That protects holders from the stock's mechanical drop on the ex-date. If you sold that put expecting the stock to stay above $50, the adjustment hasn't changed your risk; it has moved the strike to keep it where it was in economic terms.

Mergers and acquisitions

A cash takeover at $60 a share: the deliverable becomes $6,000 in cash per contract, fixed. Every option's time value collapses to zero, because nothing can change any more. A $55 call is worth exactly $5; a $65 call is worth nothing; a $50 put you sold is safe, and the premium you collected was the market's estimate of the deal breaking. After the announcement, sellers of premium on a takeover target are mostly waiting for the deal to close.

A stock-for-stock merger at a ratio of 0.8: the deliverable becomes 80 shares of the acquirer, plus any cash component. The contract now tracks a different company. Part-cash deals get a deliverable that mixes both. Spin-offs add the spun-off shares to the deliverable, so a contract might deliver 100 shares of the parent plus 25 of the new company.

How to read one

The OCC publishes an information memo for every adjustment, searchable on its website by symbol, stating the new deliverable, strike, and symbol. Brokers show adjusted contracts with a flag or a modified symbol and usually a note. Before trading any option whose quote looks strange, premium out of line with its neighbors, a symbol with a digit in it, a strike that isn't a round number, look for the memo. And before selling premium on a company with a deal announced, understand that the contract you're short may end up delivering something other than 100 shares of the company you researched.