How Options Stock Split, an article about stock splits and how it can be the beginning of a bullish move.

Options Stock Split

A stock split is actually simple to understand when you break it down.  By understanding how they work options traders can easily take advantage of these common occurrences in the market.

When a company takes their stock and decreases its value while increasing the share amount such that the price per share multiplied by the outstanding shares remains equal to the current market cap, this is called a stock split.  It allows companies to have more stock shares to sell at lower amounts.

Lets break down the more common splits.

• The 2-1 Split: This split multiplies the shares by 2, but the price is cut in half.  Example: You have 50 shares of stock at 100.00 a piece before the split now after you have 100 shares at 50.00 a piece.

• The 3-1 Split: This split triples the shares but cuts the price into thirds.  Example: You have 30 shares of stock at 12.00 a piece before, after the split you have 90 shares at 4.00 a piece.

• The 3-2 Split: This split increases the shares by 50% but cuts the price by 33%.  Example: You have 100 shares at 60.00 before the split, after you have 150 shares at 40.00 a piece.

• The reverse split: This split is the opposite of the splits above, it reduces the amount of shares but raises the price.  Example of the 10-1 split:  If you have 10 shares at 1.00 before the split afterwards you will have 1 share at 10.00.

No matter what split a company does, the value of the company stays the same.  If you start out with 5,000 dollars worth of stock, after it gets split you will still have the 5,000 dollars worth of stock.

Look at it this way:

When a stock split is done, nothing “fundamental” has changed. It’s like splitting a pencil in half. When you put the two pieces together, you still have a whole pencil.

So Why Do Companies Split Their Stocks?

It’s Simple.

Companies do stock splits for liquidity and psychology. Companies obviously need to sell stock to raise capital. By doing a stock split, they make the price of the stock more appealing to people who either do not want to spend a lot of money or who simply can not afford the higher priced shares.

What Do The Companies Get From It?

By increasing the number of shares in their stock, they can then turn around and sell them at a lower price therefore selling more shares of their stock.  This makes them raise more capital while generally increasing the amount of shareholders.

Here is an example of a real split that happened:

In 1996, Coca-Cola did a 2-1 split.  The price of the stock before the split was 81.75. In the first day of trading the shares popped by 2.5%, in the next 10 days they continued to rise to 13%. By the end of the year they had almost doubled their percentages.  They ended the year with a 40% increase in shares.

Although the reason a stock sometimes jumps after a split is unknown, it does seem to happen on a fairly regular basis.  This not set in stone, but it would seem the best time to enter a long position right before the company makes a stock split.

If you’re interested in other detailed options strategies and the types of trades we use for these types of situations, please see our options course at San Jose Options.