Stock option contract adjustments: The case of special dividends

Kathryn Barraclough, Hans Stoll and Robert E. Whaley

Journal of Financial Markets, 2012, vol. 15, issue 2, 233-257

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 (search for similar items in EconPapers)
JEL-codes: G13 G14 G15 (search for similar items in EconPapers)
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finmar:v:15:y:2012:i:2:p:233-257

DOI: 10.1016/j.finmar.2011.10.001

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