General Securities Representative (Series 7) Practice Exam

What decreases for both even and odd stock splits?

1. Number of contracts and shares per contract

2. Strike price and premium

3. Buying price and selling price

4. Underlyings' value and dividends

The correct answer is: Strike price and premium

In the context of stock splits, the strike price and premium for options contracts are adjusted to reflect the change in the underlying stock's price and quantity. With both even and odd stock splits, when a company splits its stock, the number of shares outstanding increases, and the stock price is proportionately reduced. For example, in a stock split where shares are divided, if a stock is split 2-for-1, shareholders would receive two shares for every share they owned, but the price per share reduces to half the original price. This adjustment also corresponds to options contracts associated with those shares. The original strike price and option premium must be adjusted as well to maintain the equivalent value of the options after the split. Thus, after a stock split, the strike price of the options decreases because it reflects the new, lower price of the underlying stock. Similarly, the premium, which is the price of the option, also decreases since it is directly influenced by the price of the underlying stock and perceived volatility. This alignment ensures that the relative value of the underlying investment remains consistent following a split, thereby reflecting a decrease for both the strike price and the premium.