Page 197 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes 12.4 Adjustments for Corporate Actions

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

 Adjustment for corporate actions shall be carried out on the last day on which a security is
traded on a cum-basis in the underlying cash market.
 Adjustments shall mean modifications to positions and/or contract specifications namely
strike price, position, market lot, and multiplier. These adjustments shall be carried out on
all open, exercised as well as assigned positions.

 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, consolidations, hive-off, warrants and secured premium
notes and dividends.
 The methodology for adjustment of corporate actions such as bonus, stock splits and
consolidations is as follows:
 Strike price: The new strike price shall be arrived at by dividing the old strike price
by the adjustment factor as under.

 Market lot/multiplier: The new market lot/multiplier shall be arrived at by multiplying
the old market lot by the adjustment factor as under.
 Position: The new position shall be arrived at by multiplying the old position by the
adjustment factor, which will be computed using the pre-specified methodology.
The adjustment factor for bonus, stock splits and consolidations is arrived at as follows:
 Bonus: Ratio - A:B; Adjustment factor: (A+B)/B

 Stock splits and consolidations: Ratio - A:B ; Adjustment factor: B/A
 Right: Ratio - A:B
 Premium: C
 Face value: D

 Existing strike price: X
 New strike price: ((B * X) + A * (C + D))/(A+B)
 Existing market lot/multiplier/position: Y ; New issue size : Y * (A+B)/B
The above methodology may result in fractions due to the corporate action e.g. a bonus ratio of
3:7. With a view to minimising fraction settlements, the following methodology is proposed to
be adopted:
1. Compute value of the position before adjustment.

2. Compute value of the position taking into account the exact adjustment factor.
3. Carry out rounding off for the Strike Price and Market Lot.
4. Compute value of the position based on the revised strike price and market lot.

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