Adjustment (Options)

Definition

The term adjustment refers to a change in an option contract precipitated by certain actions taken by a corporation.  Adjustments to the terms of an option contract may include its strike price, deliverable, expiration date as well as multiplier.

Explanation

When an investor buys or sells an option, the contract will include a number of variables such as the option's strike price, the stock involved in the transaction, the expiration date, as well as a multiplier.  An adjustment to the contract can occur following certain actions by the corporation issuing the stock.

Note:  All contract adjustments are governed by the Options Clearing Corporation's (OCC) By-Laws and Rules.

Example

Stock splits and mergers provide the best examples of corporate actions that may warrant a change in the terms of an option contract.  For example, if a 2-for-1 stock split is announced, the adjusted option will now include 200 shares of stock.  When this occurs, the premium is multiplied by the new factor, which in this case is 200 shares.  If the investor were to purchase one call at $2.00, the cost would be $2.00 x 200 shares, or $400.

Related Terms

assignment, cash-backed call, bull call spread