A stock split is a type of corporate action that occurs when a company’s board of directors decides to divide the company’s outstanding shares into a larger or smaller number of shares. Splits are a change in the number of outstanding shares of a company’s stock without a change in shareholders’ ownership percentage in the company. For example, with a 2:1 split, a client will receive 2 shares for each share owned prior to and through the open on the security’s split ex-dividend (or “effective”) date.
Forward splits are the division of the outstanding shares of a corporation into a larger number of shares. For example, in a three-for-one stock split (3:1), each old share is now equal to three shares. The price per share would also go down. In this example, if the pre-split share was worth $9, the post-split share would be worth $3. Usually, splits must be voted by directors and approved by shareholders.
Reverse splits are a reduction in the number of outstanding shares. For example, if you had 300 shares of XYZ and there was a one-to-three reverse split (1:3), your old 300 shares would now be equal to 100 shares. The price of each new share would also be worth more. If the pre-split share was worth $2, the post-split share would be worth $6.
When you hold a short position on a stock that has a forward split, the shares will be debited from (NOT credited to) your account. Essentially, your short position is increased due to the split.
It all starts with the Depository Trust & Clearing Corporation (DTCC), the clearing and settlement agent for U.S. securities transactions. The DTCC determines how shares will trade before and after the event.
For options, there’s the Options Clearing Corporation (OCC), which is the central clearer for all options listed in the United States. Its Securities Committee, along with an “adjustment panel” made up of representatives from exchanges, decides whether an adjustment is needed and how it should be structured. “The decision is binding for all investors,” Cruz explained. Although adjustments are made on a case-by-case basis, table 1 shows how options are typically adjusted for stock splits.
As far as splits go, Amazon’s 20-for-1 split is relatively straightforward. For every share you hold as of the record date of May 27, you’ll receive 20 shares as of the ex-date, which is June 6, 2022. After the split, each share — all else being equal — will be worth one-twentieth of what it was pre-split.
Let’s look at an example, if a company’s shares were trading at $400 per share, and you hold 100 shares, after the split, you’ll hold 400 shares, each worth $100. Note that the value of your shares doesn’t change; the value is $40,000 before and after the split. To learn more, refer to this primer on stock splits.
It’s not every day that two of the biggest companies in the United States split shares. But splits are just one type of corporate action. Others include cash dividends, stock dividends, spin-offs, mergers, and acquisitions. Although the big ones like Amazon and Tesla make the headlines, corporate actions — big and small — happen every day.
But as Cruz pointed out, corporate actions require that adjustments be made. That can include the number of outstanding shares and/or the share price, as well as the terms of listed options contracts such as strike prices and/or multipliers. “These alterations often result in contract terms that fall outside the standard 100-share contracts,” Cruz explained, “so they’re often called ‘non-standard options.”
But again, adjustments aim to keep the valuations and math the same to the extent possible.