When a Stock Splits, Do Options Split As Well?

Also, dividend plays explained, options calculators and more.
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The New Year returns us to some of the traditional bugaboos that bedevil new options traders. This week, we start the year with some basics on stock splits, dividend plays and a little bit of protection via a straightforward put play.

As the year goes on we'll continue to answer questions of all kinds and we'll be bringing in more guest authors to discuss their favorite options strategies. As usual, send your questions to Options Forum at

optionsforum@thestreet.com and we'll try our best to answer them for you.

Split Situations

What happens to a stock option when it is held during the period that a stock splits? Does it automatically split also? If someone was holding a 100 call and the stock split 2-for-1, does that mean they now hold 50 calls? Dennis Eckert

Dennis,

For each individual stock split, an exchange will put out a bulletin stipulating the new parameters of existing contracts.

Typically, though, in a two-for-one split an option series will be adjusted by the issue of one additional contract for each open contract on the ex-date and each series will have an adjusted exercise price equal to one-half of the exercise price.

The new options listed generally have different symbols than the pre-split, adjusted options.

Options exchanges usually post the split bulletins on their Web sites. The

Options Industry Council

site can lead you to each one.

Dividend Discussion

Could you explain what went on today with Chase Manhattan (CMB) options? I know it has something to do with the Jan. 4 dividend date but am a bit confused how that works. Stephen Reinhold

Stephen,

The dividend play is kind of a leftover from an earlier era, but the

Chase Manhattan

volume last week -- upwards of 30,000 contracts in at least two different strike prices -- was a clear shot at trying to capture a dividend.

Here's how it works, using

Western Digital

(WDC) - Get Report

as an example: You buy a deep in-the-money call, say the January 10, and sell another in-the-money call, say the January 12 1/2, on the ex-date. You exercise the call you bought and let the call you sold sit. In essence, you're holding a long stock position to get the dividend, and simultaneously you are short in-the-money calls.

You take the dividend, then immediately sell the stock or wait until the in-the-money calls you sold get assigned. You take in some profit on the stock -- although not much because you paid a debit to get in the position to capture the dividend -- and are now out of the stock and options positions.

While the 36-cent dividend Chase announced doesn't seem like a big deal, if an institution can pick up more than 30,000 contracts, the multiplication can lead to a nice, tidy payday.

Protection for Uncertain Times

What puts would you suggest I buy to protect my $200,000 investment in IBM (IBM) - Get Report stock for two months until I sell? Should I buy the February 180 or 185s? Regina Robinson

Regina,

We're not in the business of telling you which puts to buy, but we can outline the scenarios for either put buy.

On Friday afternoon IBM was trading at 188 3/4. Since you want to maintain your position for another month, you're right in assuming that the February puts are the ones you should buy. Since, by our calculations, you have about 1,000 shares of IBM, it would require you buying 10 puts to cover your position.

If you go for the 185 puts, which cost 7 3/4 ($775), that makes your break-even point close to 177 1/4 (185-7 3/4) if you decide you want to exercise the option to get out of your shares. If IBM falls, but not as far as 177 1/4, by expiration, it will be impossible to get what you paid for the option. The reason is that as expiration gets closer, the value of the option is increasingly dervied from intrinsic value (the difference between the strike price and the underlying stock price).

If you opt for the 180 puts, the price tag is 5 3/4 ($575.00). The rest of the math is the same. A profitable exercise would be possible at 174 1/4.

The idea, whether buying calls or puts, is to get as close to the money as possible if you don't want to pay up the cash to be in-the-money, especially if you have real concerns about a slide in IBM shares before February expiration.

Volatility Hunt

I know how to derive the implied volatility by plugging current prices into an option calculation, but is there any place or site that has historical volatility info I can use to compare with the implieds? Keep up the great work. Danny Bloomenthal

Oh, Danny Boy,

There is a host of places you can get historical volatilities, but we'd suggest the eminently credible Larry McMillan and his

Web site, which provides not only historical but recent implied volatilities under its

Free Stuff

category.

Option Calculator Update

Neil McClements of

FinTech Consultants

said his firm's Web site has a high-end options calculator that even the pros use. We can't vouch for FinTech, but we tried out the calculator and it's pretty handy.

Check it out.