What Is an Adjusted Current Option?
An Adjusted Current Option, often simply called an "adjusted option," is an options contract whose terms have been modified by a clearing organization, such as The Options Clearing Corporation (OCC), in response to certain corporate actions affecting the underlying security. As financial derivatives, options derive their value from an underlying asset. Therefore, when significant events impact the underlying asset, the corresponding option contracts must be modified to maintain fairness and ensure that the contract terms continue to reflect the economic substance of the original agreement. This falls under the broader category of Options Trading and market regulation.
History and Origin
The need for adjusting options contracts arose with the growth of the standardized options market. Before options were centrally cleared and standardized, individual contracts might have been subject to negotiation or uncertainty in the event of changes to the underlying stock. With the establishment of the Options Clearing Corporation (OCC) in 1973, a standardized framework for issuing, clearing, and settling options contracts was introduced. This standardization necessitated clear rules for how outstanding contracts would be handled when the issuer of the underlying security undertook a corporate action.
The OCC, as the sole clearing agency and issuer for standardized equity options listed on national securities exchanges, developed bylaws and rules authorizing adjustments to listed options. These rules ensure that the economic value of an option contract is preserved as much as possible for both buyers and sellers when events like stock splits, dividends, mergers, or spin-offs occur. For instance, The OCC's guidelines ensure that "corporate actions, such as rights offerings, stock dividends, and mergers can result in adjusted contracts representing something other than 100 shares of stock."15
Key Takeaways
- An Adjusted Current Option is an existing options contract modified due to a corporate action affecting its underlying security.
- Adjustments are typically made by the Options Clearing Corporation (OCC) to maintain the economic value and fairness of the contract for both parties.
- Common corporate actions leading to adjustments include stock splits, special dividends, mergers, and spin-offs.
- Adjustments can alter the number of shares per contract, the strike price, or the deliverable (e.g., a combination of cash and shares).
- Investors can identify adjusted options by changes to their trading symbols or by consulting information memos issued by the OCC.
Interpreting the Adjusted Current Option
When an Adjusted Current Option is created, its terms are modified to reflect changes in the underlying security. The Options Clearing Corporation (OCC) determines the specifics of these adjustments, which are then communicated to market participants via information memos. For example, if a company undergoes a 2-for-1 stock splits, an existing call option might be adjusted to cover twice the number of shares at half the original strike price. The goal is to ensure that the total value represented by the option contract remains equivalent before and after the corporate action. It is crucial for options traders to consult these official memos, available on the OCC's website, to understand the precise impact on their contracts.14
Hypothetical Example
Consider an investor holding one standard call option for Company ABC, with a strike price of $100 and an expiration date in three months. This contract typically represents 100 shares of ABC stock.
Suppose Company ABC announces a 1-for-2 reverse stock splits. This means for every two shares an investor owns, they will now own one share, but each share's price will theoretically double. To reflect this, the Options Clearing Corporation (OCC) will adjust the outstanding option contracts.
The investor's Adjusted Current Option would typically change as follows:
- Shares per contract: Reduced from 100 shares to 50 shares (100 shares * 0.5 split ratio).
- Strike Price: Adjusted from $100 to $200 ($100 / 0.5 split ratio).
After the adjustment, the contract still represents the right to buy the same aggregate value of stock (e.g., 50 shares at $200 per share = $10,000, which is equivalent to 100 shares at $100 per share = $10,000). While the number of shares and the strike price have changed, the fundamental economic position of the option holder is preserved.
Practical Applications
Adjusted Current Options are a fundamental aspect of maintaining an orderly and fair market for derivatives. They are crucial in situations where a company's capital structure or the value of its shares significantly changes due to a corporate action.
For investors, understanding how a put option or call option might be adjusted is vital for managing risk and making informed trading decisions. Broker-dealers and financial institutions must also be aware of these adjustments, as they impact customer accounts, margin requirements, and overall compliance with regulatory standards. Regulatory bodies like FINRA have rules regarding options, including those that are adjusted, to ensure fair and accurate reporting and to manage position limits. For example, FINRA Rule 2360 references adjusted options when discussing how covered options positions are defined.13 The specific terms of an adjustment, such as those related to cash dividends, are detailed in information memos issued by the Options Clearing Corporation (OCC). These memos provide guidance on how the adjustment maintains the contract's economic equivalence.11, 12
Limitations and Criticisms
While adjustments to options contracts are designed to ensure fairness and prevent unwarranted losses or gains due to corporate actions, they can introduce complexity for investors. The specific terms of an adjustment can vary significantly depending on the nature of the corporate action, leading to "non-standard options" or "packaged options" that might represent a different number of shares, a fractional share, or even a combination of shares and cash.10 This variability can make it challenging for investors, especially those less experienced, to fully understand the modified contract, potentially leading to confusion or unexpected outcomes upon exercise or expiration.
Furthermore, communicating these adjustments effectively to all market participants can be a challenge. While the Options Clearing Corporation (OCC) issues information memos detailing adjustments, investors may not always access or fully comprehend these technical documents. Concerns have been raised in the past by regulatory bodies, such as FINRA, about whether broker-dealers sufficiently inform their clients about these contract adjustments.9 The process of adjustment also highlights the importance of regulatory oversight to ensure the integrity of the options market during periods of corporate change. The Securities and Exchange Commission (SEC) reviews and approves rule changes by the OCC, such as those concerning the determination of adjustments, underscoring the ongoing need for clarity and transparency in these processes.7, 8
Adjusted Current Option vs. Standard Option
The primary distinction between an Adjusted Current Option and a standard option lies in their contract specifications.
| Feature | Standard Option | Adjusted Current Option |
|---|---|---|
| Shares/Contract | Typically 100 shares of the underlying security. | Can be more or less than 100 shares, fractional shares, or a combination of cash and shares. |
| Strike Price | A fixed price for 100 shares. | May be modified to reflect changes in the underlying's per-share value. |
| Origin | Listed with standardized terms from issuance. | An existing standard option that has undergone modification due to a corporate action. |
| Symbol | Usually a simple ticker symbol. | May have an altered or added suffix to indicate its adjusted status (though not always).6 |
| Complexity | Simpler, widely understood terms. | More complex due to non-standard deliverables or terms. |
An Adjusted Current Option arises from a standard option when a significant event, like a stock splits, mergers, or special dividends, affects the underlying security. The modification is intended to preserve the contract's original economic value, but it results in a non-standardized contract.
FAQs
Why do options contracts get adjusted?
Options contracts, including what becomes an Adjusted Current Option, are adjusted primarily to maintain fairness and to preserve the economic value of the contract when the underlying asset is affected by a corporate action. Without adjustments, events like stock splits or special dividends could unfairly benefit one party of the options contract over the other.
Who is responsible for adjusting options contracts?
The Options Clearing Corporation (OCC) is the primary organization responsible for determining and implementing adjustments to listed options contracts in the United States. They issue detailed information memos outlining the specific changes to be made.5
How can I tell if an option contract has been adjusted?
An Adjusted Current Option may have a different trading symbol, often with a numerical suffix, though not all adjustments result in a new symbol.4 The most reliable way to identify and understand an adjusted contract is to consult the information memos published by The Options Clearing Corporation (OCC) on their website.2, 3
Do all corporate actions lead to an options adjustment?
Not all corporate actions necessarily lead to an options adjustment. Minor cash dividends, for instance, may not trigger an adjustment if they fall below certain thresholds set by the Options Clearing Corporation (OCC).1 Only corporate actions deemed to materially impact the value or composition of the underlying asset will typically result in an Adjusted Current Option.