Share splits, also known as stock splits, are corporate actions in which a company increases the number of outstanding shares while in proportion reducing the share price. This can have implications for investors, particularly in terms of options trading.

For example, in a 2-for-1 share split, an investor who owns 100 shares at $100 per share would receive an additional 100 shares, reducing the price to $50 per share. The total investment value remains unchanged at $10,000 ($50 x 200 shares).

Why do companies decide on share splits?

While share splits do not change the fundamental value of the company, management teams often choose this course of action for several reasons, including to boost the company’s marketability, liquidity and visibility. A lower share price can also make the stock more attractive to retail investors who prefer lower-priced shares.

This heightened interest can potentially drive-up demand in the short term for the stock and increase the company’s market capitalisation. The perception of a company’s stock price can influence investor behaviour and market sentiment and may create the illusion of a more affordable investment opportunity, attracting new investors and boosting demand for the stock.

Another major advantage of share splits is the potential for increased liquidity. A higher number of outstanding shares can lead to more trading activity, making it easier for investors to buy or sell shares without significantly impacting the stock price. This improved liquidity can result in a more efficient market for the company’s stock.

Impact on options

When it comes to options trading, share splits can have implications for put and call options. Following a split, the terms of existing options contracts are adjusted to reflect the new share price and number of shares. For example, in a 2-for-1 split, the strike price of options contracts would be halved, while the number of shares covered would double.

The primary advantage for investors is the increased affordability and liquidity in options trading after a share split. Since the share price is reduced, options contracts become more accessible to a broader range of investors, lowering the entry prices on the contracts.

The increased affordability of options post-split allows investors to explore more advanced risk management strategies, without incurring excessive costs that may have been associated with the pre-split prices. As an example, by using put option contracts to mitigate downside risks or hedge existing positions, investors can safeguard their investments more efficiently.

Conclusion

Share splits are a deliberate move employed by companies to make their stock more accessible, improve market visibility, and increase liquidity. While they offer potential advantages such as improved marketability and increased trading activity, share splits also come with risks, such as dilution of ownership and potential market volatility. By making options more accessible, share splits let investors diversify their portfolios, implement refined strategies, and manage risks more efficiently.

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