Citigroup Inc. ( C ) has announced a 1-for-10 reverse stock split. For shareholders, this is a straightforward, easy-to-understand transition. On the X-date of the reverse split, stockholders will get one share for every ten they own and the value of the shares will be ten times greater.
Before and after the split, the trader will have the same value of stock. For example, if, before the reverse split, a trader has 100 shares of C and it is trading at $5 a share, the trader owns $500 of C stock (100 shares times $5). After the reverse split, the trader will have ten shares worth $50 each. That means the trader would still have $500 worth of stock (10 times $50).
But the options can get a bit more confusing. The important thing to understand is that the value of the aggregate options position will remain the same (barring any market price fluctuation). Here’s how it works.
Right now, if a trader exercised a C June $5 call, he’d pay $500 and get 100 shares (that’s $5 a share). If a trader waits until after the split, he or she will still have a $5 call, but its exercise implications will be a little different. Even though C will be trading significantly higher—closer to $50 than $5—the call will not be considered deep-in-the-money; it is an unconventional options class because of its exercise. If a trader exercises a $5 C call after the split, he or she will still pay $500, but will get only 10 shares of stock. The multiplier remains the same—100. So the call still gives the right on $500 of C stock.
In options lingo, the notional value remains the same. That is the monetary value of the shares that can be controlled by an option. So, though the options are a little different from an exercise perspective, traders still have the same notional value that they had before the split.
After the split, there will be new Citigroup options listed that will trade in addition to the “old” Citigroup options. They will be conventional—when a trader exercises an option, 100 shares of the underlying trade at the strike price. The strike prices for the new Citigroup will be much more aligned with the price of the underlying than the “old” Citigroup options in which calls will appear to be deep-in-the-money and puts will appear to be far-out-of-the-money.
With splits and reverse splits, the important thing to understand is that no position value is gained or lost as a result of the split. Price and quantity are adjusted to ensure position value remains constant.
Dan Passarelli is the President and CEO of Market Taker Mentoring LLC, http://markettaker.com.