Investments

20 September 2024

By Scott Newitt

Share splits are where companies increase the number of shares on issue for liquidity reasons or to make the stock more attractive to retail investors. This can have share price implications, 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.

To discover more call 1300 683 106 or email us on investordesk@nab.com.au

View all Investment Insights and Articles

The information contained in this article is gathered from multiple sources believed to be reliable as at September 2024 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. NAB does not guarantee the accuracy or reliability of any information in this article which is stated or provided by a third party. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article.

©2024 NAB Private Wealth is a division of National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686.Insert article here

Investments