One example of a derivative is a call and put option on a stock. A holder of a call can buy shares of a company at specified price (strike price) prior to option’s expiration date. On the other hand, a put holder can sell shares of a company at specified price prior to expiration.
Stock splits and option contracts
When it comes to American options, a standard option contract on a stock represents 100 shares. If there’s a stock split, the contract gets adjusted. For instance, if there’s an option for 100 shares of company XYZ at $20 strike price, and there’s a 2-for-1 stock split, the strike price will be changed to $10, and there will be two contracts for one. However, if there’s a 3-for-2 stock split, each contract will represent 150 shares and the strike price will be adjusted to $13.33.
Calls and puts on bonds
There are also options on bonds. Calls allow the issuer to redeem the options prior to maturity at a specified price by a specified date, while puts allow the bondholders to sell their bonds to the issuer also at a specified price prior to a specified date. If a company exercises a call, it is a mandatory action. However, put exercises are up to bondholders, therefore, they are considered to be voluntary actions.
Corporate actions related to warrants
Stock warrants can also be considered as options. The corporate actions related to warrants include warrant issues, exercises, and expiries. Companies issue warrants for various reasons such as raising additional capital (when warrant is issued and exercised into shares at a set price).
Warrants have exercise price and expiration date. If, for instance, warrants can be exercised at $20 for a share of a stock, and the stock trades at $30, then the warrants are in-the-money and can be exercised, traded in the market, or held in expectations that the stock price will rise further prior to their expiration date.
If warrants are out-of-the money (the exercise price is higher than the stock price), then they’re likely to expire worthless. Out-of-money warrants can also be sold in the market to other investors, but their value would be limited to their time value, which is time left to expiration during which there’s a possibility that the stock will rise.
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Derivatives are financial products that derive their value from the instruments they’re based on. Here we discuss impact of corporate actions on derivatives.
Options can be exercised, traded, or can expire worthless