How Adjusted Exercise Price Works

The adjusted exercise price is the striking price of an option contract after you take into account corporate activities, such as stock splits or special dividends to the underlying securities. Any time specific corporate actions change the underlying security on which options are written, companies must modify the strike price and delivery quantity of the underlying asset to guarantee that neither the long nor short holder of the options suffer a loss. However, before the corporate action that affects the underlying price or qualities, the adjusted strike price enables trading continuity for option contract holders. You must also note that adjusted exercise prices typically exist until an impacted options series expires, after which new strike prices are applied post hoc.

If the underlying stock experiences reorganization that directly impacts the initial terms of its options, the terms of the options contract changes. Special dividends, stock splits, and stock dividends are instances of this. For example, a two-for-one stock split will lead to twice the number of shares at half the price. Because of the two-for-one stock split, you as the holder of an option contract will receive twice as many option contracts at half the original strike price.

Fractional strike prices may occur from adjusted exercise prices, but only for options series that existed before the corporate action that generated the adjustment. The company will introduce new strike prices to both new and current series that are largely unadjusted after the fact. It's worth noting that strike prices aren't altered for routine dividends, ticker symbol changes, or mergers and acquisitions.

Example of Adjusted Exercise Price

Assume you started working at Cakes-Ent when the stock was trading at exactly $20. As a thank you for enrolling, the company gave you ten thousand alternatives. The stock performed exceptionally well, climbing as high as $50 a share before the corporation implemented a two-for-one stock split. As a result, the shares moved from trading at $50 per share to $20 per share shortly after the stock split was implemented.

You might be upset if you hadn't read this definition because the extra $30 value in-the-money stock option off of your $20 strike price, when removed from the $50 market price, has just vanished. However, the stock only spilt, and nothing actually vanished. Thus, your existing shares divided as well––you went from having ten thousand options to twenty thousand options, and your strike price, which was originally $20, is now $10.

So you had exactly $3,000 in intrinsic worth in your stock option the right before the stock split, or ten thousand options times the quantity $50 - $20 = $30. So you had no less than $300,000 in cool cash. The day after the stock split, you had 20,000 options with a strike price of $10 and a stock price of $25. The math is 20,000 options multiplied by $15 intrinsic value, or in the money option value, equals the same $300,000 in value as the day before the stock split.