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Stock option contract adjustments: The case of special dividends

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  • Barraclough, Kathryn
  • Stoll, Hans R.
  • Whaley, Robert E.

Abstract

The terms of stock option contracts are adjusted in the event of unexpected corporate actions, and the nature of the adjustments may result in windfall gains or losses to open option positions. This paper evaluates the fairness of the two different procedures used for special cash dividends. We show that, while neither procedure is technically correct, the absolute adjustment used in the U.S. and Canada minimizes the windfall change in option value when the dividend is announced. In addition, the proportional adjustment used in Australia and Europe depends on stock price and is therefore vulnerable to temporary aberrations in the stock market.

Suggested Citation

  • Barraclough, Kathryn & Stoll, Hans R. & Whaley, Robert E., 2012. "Stock option contract adjustments: The case of special dividends," Journal of Financial Markets, Elsevier, vol. 15(2), pages 233-257.
    • Handle: RePEc:eee:finmar:v:15:y:2012:i:2:p:233-257
    DOI: 10.1016/j.finmar.2011.10.001
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    References listed on IDEAS

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    Cited by:

    1. Angel Tengulov & Robert E. Whaley, 2020. "Levered and inverse VIX ETP option contract adjustments: No harm, no foul?," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(4), pages 3253-3277, December.

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    More about this item

    Keywords

    Stock option; Special dividend; Contract adjustment; Displaced diffusion process; Nested binomial lattices;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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