What Is Adjusted Future Option?
An Adjusted Future Option refers to an options contract whose original terms have been formally modified due to corporate actions affecting its underlying asset, which in this case is a futures contract. This concept is integral to derivatives trading and ensures that the economic value of existing options positions is preserved despite significant changes to the underlying security or commodity.
When an Adjusted Future Option is created, critical elements of the contract, such as the strike price, the number of underlying units, or even the deliverable asset, may be altered. The aim is to maintain fairness for both the option holder and the option writer, preventing unintended gains or losses solely due to a corporate event.
History and Origin
The evolution of options contracts and their subsequent adjustments are intertwined with the development of organized financial markets. While options have existed in various forms for centuries, the modern era of standardized options trading began in 1973 with the establishment of the Cboe (formerly the Chicago Board Options Exchange).12 As the market for derivatives expanded, particularly with the introduction of options on futures contracts, the need for clear guidelines regarding adjustments became evident. Options on futures were first traded in October 1982 when the Chicago Board of Trade (CBOT), now part of CME Group, began trading options on T-bond futures.11
Corporate actions like stock splits, mergers, or special dividends frequently alter the nature of the underlying assets. To ensure the integrity and continuity of existing options, standardized adjustment procedures were developed. The Options Clearing Corporation (OCC) plays a crucial role in this process, issuing memos that detail the specific adjustments to be made to outstanding options contracts following such events.10
Key Takeaways
- An Adjusted Future Option is a futures option contract whose terms have been altered due to a corporate action affecting its underlying.
- The primary purpose of adjustment is to preserve the total economic value of the original contract for both buyer and seller.
- Adjustments can involve changes to the strike price, the number of underlying units, or the deliverable.
- The Options Clearing Corporation (OCC) is the entity responsible for determining and implementing these adjustments for standardized options.
- Adjusted Future Options may experience reduced liquidity and open interest compared to unadjusted contracts.
Formula and Calculation
An Adjusted Future Option does not have a single, universal formula for its value. Instead, the "adjustment" refers to the modification of the contract's specifications (such as its strike price or the number of deliverable units) to reflect changes in the underlying futures contract or its reference asset. These adjustments are determined by the Options Clearing Corporation (OCC) and are specific to the type of corporate action that occurred.9
For example, in a two-for-one stock split affecting a stock underlying a stock index futures contract, and by extension, options on that futures contract, the original option holder might be granted twice the number of contracts, each at half the original strike price. The goal of these modifications is to ensure that the aggregate value of the option position remains consistent with its pre-adjustment economic standing.
Interpreting the Adjusted Future Option
Interpreting an Adjusted Future Option requires careful attention to its modified terms. Unlike standard options contracts, the terms of an adjusted contract may not align perfectly with the standard option chains for the same underlying asset. Traders often identify an Adjusted Future Option by checking for specific symbols or numerical suffixes appended to the option symbol, which indicate an adjustment has occurred.8
It is crucial to understand the new strike price and the revised number of deliverable shares or units associated with the Adjusted Future Option. These changes can significantly impact the option's perceived value, its premiums, and how it behaves in relation to the underlying asset's price movements. Due to their non-standard nature and increased complexity, Adjusted Future Options tend to have lower liquidity and reduced open interest compared to standard options.7 If an option's price appears misaligned with the underlying, it could be an indication that an adjustment has taken place.6
Hypothetical Example
Consider an investor who holds a call option on a futures contract tracking a hypothetical "Tech Index Future." This option grants the right to buy the Tech Index Future at a strike price of 5,000, expiring in December. The Tech Index is composed of several large technology stocks.
Suppose one of the largest constituent stocks in the Tech Index announces a 2-for-1 stock split. Following the split, the value of the Tech Index itself would typically adjust downward to reflect the increased number of shares. To ensure the investor's call option on the Tech Index Future retains its original economic value, the Options Clearing Corporation (OCC) would issue an adjustment. This adjustment might halve the strike price of the existing option to 2,500 and double the number of futures contracts the option controls, or it might modify the multiplier of the contract12345