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, Random Roger (123 clicks)
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A few days ago Google (GOOG) announced a stock dividend (essentially a stock split) whereby the price of one share of their current class A shares will be cut in half price-wise and they will get one share of a new class C share that will start at the same price, but the voting eligibility between the two will be different. This post is not really about the specifics of the split so if you want more information just look up news for GOOG.

In the aftermath of the news I found this post at Seeking Alpha about what will become of the options. It was not clear to me whether the author knew what would happen with the options or did not know but existing options will become adjusted options and new options for the post-split shares will be issued.

The strike prices of the adjusted options will stay the same but the underlying shares will be different. Instead of a call option struck at $600 representing 100 shares with an at the money value of $60,000, the adjusted option will be at the money when the value of 100 shares of the class A and the value of 100 shares of the class add up to equal $60,000. If 100 shares of class A is worth $32,500 and 100 shares of class C is worth $31,000 then the adjusted option struck at $600 would be in the money by $35/share.

The reason to mention this is a behavior that seems to repeat in these situations. After the split the adjusted options will be listed right next to the unadjusted options. People will see one $500 call option that is close to worthless and another one at something like $130 or $140 while the stock is at $300. They will think they can sell the $500 call option that is $200 out of the money and pocket the $130-$140 premium--FREE MONEY!

Of course they are not selling a call option $200 out of the money but are actually selling a call option $130 points in the money and are actually naked for not having the 100 shares of class C they need for the position to be covered.

If you are lucky and spend a lot of time with option chains then you might, I say might, find occasions where the options market gives away nickels and dimes worth of premium but the options market does not give away hundreds of dollars in premium. Maybe you have experience understanding adjusted options but I promise that there will be people trying to do exactly the trade I describe above. Because it has been so long since I worked at a brokerage firm (I have worked on the buy side for many years now), I don't know if they try to protect clients from their own greed in these situations.

Source: Google's Stock Split: The Options Market Does Not Give Money Away