10 Things to know about Stock Splits
The stock split is a unique scenario in the company’s lifecycle that happens 3 to 4 times of its existence. The only extremely successful company had more than 4 stock splits.
The stock split is the process of splitting the number of outstanding shares into smaller pieces to make them affordable to all public traders. A stock split is decided by the company’s board of directors. On the stock split, the number o shares increase as per the decision made by the company.
The company decides to split the stock when they believe that the stock price is high for the public to participate. In general, traders have mentally to buy cheaper stock price (Comment if you disagree!!). So if more traders participate in buying the stock, the demand for the stock increases creating an increase in stock price and overall value of the company. That will make the board and the investor wealthy.
In general stock split will be 2 for 1 or 4 for 1 and rarely 10 for 1, for example, 2 for 1 means that when the shareholder holds 1 stock, it will be converted to 1. If the company had 100 million stocks outstanding means it will be converted to 200 million. It increases liquidity because we have more stocks to buy in the market than before even though the value of the stock remains the same.
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The stock split is the action made when the company is confident about its value because it is a major decision taken. When a company chooses to do a stock split when they are not doing well, they will be scrutinized and the value of the company may fall further. Company values increase when the company chooses to do a stock split.
What you need to know about the stock split:
- When the stock split happens what is the parameter that changes. Let us take 2 for 1 is the stock split:
- Market capitalization means the same
- The number of outstanding shares doubles.
- Face value of the stock halves.
- Enterprise values remain the same.
- Earning per share halves.
- P/E(Price to earnings) remains the same.
How stock split impacts futures and options?
Most of the blogs do not cover the information. I found it hard to find this information when I was new to trading.
All the prices are halved and lot size will be doubled if the company plans to give a 2 for 1 split. So overall value remains the same.
Future: stock price was at 100 and you bought the futures at 101 for the month’s expiry and the lot size is 2000. If we have 2 for 1 split.
Then stock price becomes 50, your future price will be at 50.5 and lot size will become 4000.
Options: stock price was at 100 and you bought the 101 calls for 2 rupees, for the month’s expiry and the lot size is 2000. If we have 2 for 1 split.
Then option price will be 1 for the strike price of 50.5 and the lot size becomes 4000.
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Reverse splits:
A rare occasion in the stock market compared to stock splits. It’s exactly the reverse of what a stock split does.
When the company decided to choose a small price during the IPO and it feels that price is very low where people tend to think that the company is penny stock. People will feel penny stocks are not safe (Comments if you disagree). So the company will decide the reverse split where it increases the stock price based on the board of director’s approval.
1 for 2, 1 for 4, 1 for 10 were the example of reverse splits. Everything parameter will be exactly vice versa to that of Stock splits.
Hope this blog was helpful. Comment if you have any doubts or if you want to prove me wrong.
