DERIVATIVE ADJUSTMENTS FOR CORPORATE ACTIONS

Corporate Actions are instances where some action is taken by the company as a result of which the share price will react. Common examples are dividends, bonus, rights, stock splits, mergers and demergers. The prices of futures and options will be influenced by such actions along with the impact on prices of the underlying shares themselves. This article seeks to understand the impact on prices of futures and options and the practices which exchanges will follow to structure that impact in a transparent manner.

Principle for Price Adjustment

The basis for any adjustment for corporate actions shall be such that the value of the position of the market participants, on the cum and ex-dates for the corporate action, shall continue to remain the same as far as possible. This will facilitate in retaining the relative status of positions viz. in-the-money, at-the-money and out-of-money. This will also address issues related to exercise and assignments.

Corporate Actions to be adjusted

The corporate actions may be broadly classified under stock benefits and cash benefits.

The various stock benefits declared by the issuer of capital are:

• Bonus

• Rights

• Merger / De-merger

• Amalgamation

• Splits

• Consolidation

• Hive-off

• Warrants

• Secured Premium note(SPNs) among others. 

The cash benefit declared by the issuer of capital is cash dividend.

Time of Adjustment

Any adjustment for corporate actions would be carried out on the last day on which a security is traded on a cum basis in the underlying equities market, after the close of trading hours.

Adjustment

Adjustments may entail modifications to positions and / or contract specifications as listed below, such that the basic premise of adjustment laid down above is satisfied:

a) Strike Price
b) Position
c) Market Lot / Multiplie

The adjustments would be carried out on any or all of the above, based on the nature of the corporate action. The adjustments for corporate actions would be carried out on all open, exercised as well as assigned positions.

Methodology for adjustment

1. Bonus, Stock Splits and Consolidations

   B. Dividends

• Dividends which are below 10% of the market value of the underlying stock, would be deemed to be ordinary dividends and no adjustment in the Strike Price would be made for ordinary dividends. For extra-ordinary dividends, above 10% of the market value of the underlying security, the Strike Price would be adjusted.
• To decide whether the dividend is "extra-ordinary" (i.e. over 10% of the market price of the underlying stock.), the market price would mean the closing price of the scrip on the day previous to the date on which the announcement of the dividend is made by the Company after the meeting of the Board of Directors. However, in cases where the announcement of dividend is made after the close of market hours, the same day's closing price would be taken as the market price. Further, if the shareholders of the company in the AGM change the rate of dividend declared by the Board of Directors, then to decide whether the dividend is extra-ordinary or not would be based on the rate of dividend communicated to the exchange after AGM and the closing price of the scrip on the day previous to the date of the AGM.
• In case of declaration of " extra-ordinary " dividend by any company, the total dividend amount (special and / or ordinary) would be reduced from all the strike prices of the option contracts on that stock.
• The revised strike prices would be applicable from the ex-dividend date specified by the exchange.

   C. Mergers

• On the announcement of the record date for the merger, the exact date of expiration (Last Cum-date) would be informed to members.
• After the announcement of the Record Date, no fresh contracts on Futures and Options would be introduced on the underlying, that will cease to exist subsequent to the merger.
• Un-expired contracts outstanding as on the last cum-date would be compulsorily settled at the settlement price. The settlement price shall be the closing price of the underlying on the last cum-date.
• GTC/GTD orders for the futures & options contracts on the underlying, outstanding at the close of business on the last cum-date would be cancelled by the Exchange.

The relevant authority may, on a case by case basis, carry out adjustments for other corporate actions in conformity with the above guidelines, including compulsory closing out, where it deems necessary.

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