With the recent rise in share prices, we're beginning to see a pickup in merger and takeover activity. And who knows, stocks may start splitting on a regular basis again in the not-too-distant future. This week's question addresses how the options market adjusts to changes in an underlying company's structure or share price.

I was thinking about buying some T options. However, when I checked the quotes I get three different symbols for the Jan 2004 25 Calls. I have +keuae, +tae and +titae. I tried to find out what they mean but couldn't find anything. I'm sure there's gotta be a difference. What is it?? I would be very thankful if you could send me a link. Thank you very much, Roman.

While the specifics surrounding AT&T ( T) maneuverings were the result of a falling market and an essentially floundering company, it's a great working example of what happens to options when the underlying equity effects a spinoff, spinout or split -- it's performed all three during the past three years. The impact on related options is basically applicable to all situations.

The General Rules

The concept related to stock splits is that an option's aggregate exercise value always remains the same. If XYZ Corp. is trading at $60 and announces a 2-for-1 split, the owner of one 60 strike (or put), regardless of the month, gets two 30 strike calls (or puts) when the split occurs.

In the case of a fractional split, such as a 3-for-2, the 60 strike becomes a 40 strike on 150 shares; each still represents a $6,000 aggregate value of the underlying.

This idea essentially answers the question:

"I bought 500 shares of stock and wrote five November calls against it. The stock has split 4-for-3, am I now short two of five calls? T.D."

My best, short answer is no. I'll take TD's caginess in not revealing his actual holdings to reiterate that you should always check with your broker regarding the implications of your specific position. But again, basic division would most likely be applied, meaning each contract now represents 133 shares. Assuming you held the underlying stock -- which would now be 665 shares -- they will all be covered by the five calls.

Acquisitions or mergers will usually result in the outstanding options being adjusted to require delivery or securities payable to holders of the security after the deal is completed. There's a good example on the CBOE Web site. But when cash is involved (as has been the case in the most recent deals), options will be adjusted for the cash delivery -- the expiration date is accelerated to fall before the conversion of the underlying is due to receive the cash, so the options lose their time premium. In-the-money holders must exercise the option prior to this date or risk it expiring worthless. For more details, look at the Characteristics and Risks of Standardized Options booklet, specifically Chapter 3 on the CBOE Web site.

With a spinoff, the value of the underlying and the option will again be adjusted to reflect the aggregate value. For example: If each owner of 100 shares of ABC Corp. receives 10 shares of the "spinoff" and you owned a $60 call, the options will be adjusted to include both the original 100 shares plus 10 shares of the spinoff. When a specific announcement is made and terms are finalized, the option exchanges will publish an explanation of how the option is adjusted and usually issue a new ticker symbol.

This brings us back to Roman's original query (thanks for your patience, Roman). As a result of AT&T's sale of its broadband business to Comcast ( CMCSA), several new classes of stock and options were created effective Nov. 20, 2002, making for some ungainly accounting and fairly complex adjustments. Putting it simply, every 100 shares of the original AT&T now represents 100 shares of T, 32 shares of the new Comcast and 32 shares of AT&T Wireless ( AWE), which was the result of the July 2001 spinoff and $2.95-a-share cash distribution.

If that wasn't enough, once these distributions were made, AT&T then performed a 1-for-5 reverse stock split in order to get its share price back to a respectable level. So, assuming you owned 100 shares of AT&T at the reduced price of $5, (plus all the other goodies described above) you now had just 20 shares priced at $25. And the options were assigned new tickers with the T, LT and ZT symbols becoming ATZ, KEU and ZTQ, accordingly. For specific information on this -- and it's good practice looking this stuff up -- you should look at this page . For other general information regarding splits, spins and mergers, go to the CBOE's trading tools page.
Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to Steve Smith.