Stock Option Contract Adjustments: The Case of Special Dividends

42 Pages Posted: 15 Nov 2009 Last revised: 17 Nov 2012

See all articles by Kathryn Barraclough

Kathryn Barraclough

Independent

Hans R. Stoll

Vanderbilt University - Finance

Robert E. Whaley

Vanderbilt University - Finance

Date Written: November 11, 2009

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.

Keywords: stock option, special dividend, contract adjustment, displaced diffusion process, nested binomial lattices

JEL Classification: G11, G13, G14, G15

Suggested Citation

Barraclough, Kathryn and Stoll, Hans R. and Whaley, Robert E., Stock Option Contract Adjustments: The Case of Special Dividends (November 11, 2009). Available at SSRN: https://ssrn.com/abstract=1430558 or http://dx.doi.org/10.2139/ssrn.1430558

Kathryn Barraclough

Independent

Hans R. Stoll

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States
615-322-3671 (Phone)
615-343-7177 (Fax)

Robert E. Whaley (Contact Author)

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States
615-343-7747 (Phone)
615-376-8879 (Fax)

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