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Kinder Morgan Canada did a share consolidation that took effect today. I see there are still options out there that reflect the unconsolidated price. Would someone buying the put option after the consolidation be able to take advantage of the large price drop or are there protections in place that prevent sale of options when a share consolidation occurs?

  • As a side note I'm not set up to trade options myself so if this an actual opportunity have at it. – Myles Jan 7 at 18:53
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I don't the details of your share consolidation so I can't answer your specific question about Kinder Morgan Canada. My guess is that you are seeing some adjusted and unadjused options.

Option contracts are adjusted when there is a significant corporate event affecting the underlying stock. Examples are a stock split, reverse stock split, merger, acquisition, special dividend, spin-off, etc.. When one of these events, the option is altered to reflect the changes.

The simplest event is the stock split.

  • 2 for 1: You get 2x as many contracts with a strike price of 1∕2 the original strike price
  • 3 for 1: You get 3x as many contracts with a strike price of 1∕3 the original strike price
  • 3 for 2: You have the same number of contracts with a strike price of 2∕3 the original strike price and the multiplier changes from 100 to 150
  • 1 for 5 reverse split: No change to strike price or multiplier and the delivery becomes 20 shares

The adjustments get more complex as the terms of the corporate event get more complex. Here's an example of how the OCC handles it (US options):

https://www.theocc.com/components/docs/market-data/infomemos/2009/jan/25361.pdf

One thing is for sure when these occur. There is no arbitrage opportunity. There is no free money. All of the changes in the underlying are accounted for in the options after adjustments are made.

What can be confusing is that after a corporate event such as a special dividend, new standard contracts are issued and their terms are very different from the adjusted contracts.

Some tip offs that a contract may be adjusted:

  • the option seems much too cheap or too expensive
  • there are two different option symbols with the same month and strike price
  • the abbreviation “ADJ” appears in the option's description
  • a number such as 1 or 2 is added as a suffix to the underlying stock symbol.
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Would someone buying the put option after the consolidation be able to take advantage of the large price drop or are there protections in place that prevent sale of options when a share consolidation occurs?

No - there is no arbitrage opportunity here. In the event of a corporate action like a split or consolidation, the exchange will adjust the quantity and strike of any outstanding options to reflect the new stock price.

So if a stock was trading at $10 and you had a $12 call option contract on 100 shares, then splits to a price of $5, your call option will be adjusted by the exchange to two $6 call option for a total of 200 shares. So the overall value will not change, since the price and strike will be halved and the quantity doubled.

If your broker is still listing the old strikes, it's possible that they haven't adjusted their data to the new share price.

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    So if I understand correctly the exchange will scale both options that had been purchased as well as those currently for sale? – Myles Jan 7 at 19:28
  • Not sure what you mean by "for sale" but any existing offers (bid/ask) should be adjusted as well. I suspect your broker just hasn't reflected that yet. – D Stanley Jan 7 at 19:32
  • If the stock is at $10 and you own a $12 call on 100 shares and the stock splits 2:1, the strike price halves and the number of contracts doubles. The contract does not go to 200 shares. – Bob Baerker Jan 7 at 19:59
  • DS: YW. @Myles - the exchange will adjust options that existed before the corporate action. After it, new option contracts will be standardized and will have nothing to do with the corporate action. – Bob Baerker Jan 7 at 20:15
  • @BobBaerker Lag in the adjustment through the brokerage seems to create ugly pitfalls. In this example if I offer a bad strike price on the day before consolidation (let's say $7), it may look good for a few hours the next day until it adjusts down to $3.50. – Myles Jan 7 at 20:41

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