Adjusted Options

A reader asked what happens to an option if there is a special dividend or spinoff. The short answer is that the option holders are not left out in the cold. Options do get adjusted when there are corporate events like the ones above. I will say that I am not sure that there can be an exact to the penny adjustment however. For example is the volatility in Altria options just a hair high because of the Kraft spinoff that appears to be coming in the next few months? Could an option holder be out a couple of cents if volatility declines after the terms of the spinoff are announced?

With a spinoff it is likely that post spinoff the options will deliver a combo of the two different stocks. Sticking with MO, and the Kraft spinoff, the current MO options deliver MO shares, after the spinoff the old MO options will be adjusted to deliver MO and KFT shares. Specifically a MO call today struck at 80 delivers $8000 worth of stock; 100 shares at $80. After the spinoff the $80 call will deliver a package of MO and KFT, consistent with the spinoff, that is worth the same $8000.

With special dividends the strike price is usually adjusted down by the amount of the dividend. There is a threshold where the strikes get adjusted but I am not sure at what point this happens. With the Microsoft special dividend from a few years ago the strike prices were adjusted down. Again the option holders are generally left whole but there may not be precise to the penny protection.

I am not the expert on this to be sure and there can be times where the adjustments can be much more difficult to grab onto but this is the basic nuts and bolts.