The Impact of Corporate Actions on F&O Contracts 

When it comes to derivatives trading, Futures and Options (F&O) contracts are essential tools for investors to hedge risks or speculate on price movements. In this context, corporate actions are decisions made by a company that bring changes to its securities, and they can significantly impact these contracts. Understanding how these actions affect F&O contracts is crucial for traders to manage their positions effectively and avoid unexpected losses.

Corporate actions such as dividends, stock splits, rights issues, and mergers can alter the value of underlying stocks, and therefore require adjustments to F&O contracts to ensure a fair and smooth transition. SEBI and stock exchanges have laid down clear guidelines for handling such changes to protect the interest of all market participants.

Let’s dive deeper into how corporate actions impact F&O contracts and what traders should watch out for.

What are Corporate Actions?

Corporate actions are decisions taken by a company’s board that directly affect shareholders. These actions can change the financial structure, stock price, or number of shares in circulation. Some of these actions also affect futures and options contracts based on the underlying stock.

Common Corporate Actions:

• Dividends (Interim or Final)
• Bonus issues
• Stock splits
• Rights issues
• Mergers and acquisitions
• Buybacks and spin-offs

Not all corporate actions affect F&O contracts, but when they do, they require specific adjustments by the exchanges.

Types of Corporate Actions That Affect F&O 

Not all corporate actions necessitate adjustments in F&O contracts. The ones that do typically alter the value or structure of the underlying stock. Key corporate actions affecting F&O include:

1. Dividends

Dividends are cash payments made to shareholders to reward them for their loyalty to the company. If the dividend is significant (typically more than 10% of the stock's price), it may lead to adjustments in F&O contracts.

• Ordinary Dividends: Do not require an adjustment in the F&O contract.
• Extraordinary Dividends: If the dividend amount is more than 5% of the underlying stock’s closing price (on the day before the ex-dividend date), the strike price and future price are adjusted accordingly.

For example, if a stock closes at ₹200 and announces a dividend of ₹15 (which is 7.5% of ₹200), the strike prices of options and the futures price will be reduced by ₹15 on the ex-dividend date.

2. Bonus Issues

Bonus issues are additional shares given to existing shareholders, free of cost in a certain ratio, leading to changes in the number of shares and potentially affecting contract specifications. 

• Adjustment: The lot size increases, and the strike price adjusts proportionately.

For example, a 1:1 bonus (one free share for each share held) will double the number of shares per lot, and the strike price will be halved.

3. Stock Splits and Consolidations 

A stock split means the division of existing shares into multiple ones, altering the share price and quantity, which impacts the lot size and strike price of F&O contracts.

• Stock Split: A single share is split into multiple shares.
• Consolidation (Reverse Split): Multiple shares are merged into one.

Impact:

• The lot size changes to reflect the new number of shares.
• The strike price is adjusted to reflect the new price per share.

For example, if a stock undergoes a 2:1 split, one share becomes two. If an F&O contract had a lot size of 500 shares, it becomes 1000 shares, and the strike price is halved.

4. Rights Issue 

In a rights issue, a company offers new shares to existing shareholders at a discount, which can affect the stock's value and necessitate contract adjustments.

Adjustment:

• Both strike prices and lot sizes are recalculated to maintain contract value neutrality.

For example, a 1:5 rights issue at ₹ 100 when the stock is trading at ₹ 150 will result in a weighted average price adjustment for strike prices.

5. Mergers and Acquisitions

Combining companies or one company acquiring another can lead to significant changes in the underlying asset, requiring contract modifications, because the underlying asset may cease to exist or be replaced with a new one.

Impact:

• The exchange may discontinue contracts or adjust them to the new company’s stock, depending on the structure of the deal.

Adjustments in Strike Prices and Lot Sizes

When a corporate action affects the underlying stock, SEBI and the exchanges adjust F&O contracts to ensure fairness and maintain the economic value of positions. The primary adjustments include:

• Strike Price: The price at which the option can be exercised is recalibrated to reflect the corporate action's impact.
• Lot Size: The number of shares in one contract is adjusted to maintain the contract's overall value.
• Market Price: The base price of the futures contract may be modified to align with the new stock price post-corporate action.

Basic Adjustment Formula:

These adjustments regarding the revised strike price and lot size are typically made using an adjustment factor, ensuring that the contract's value remains consistent before and after the corporate action.

Example – Bonus Issue Adjustment:

Original F&O lot size: 100
Strike Price: ₹ 200
Total Contract Value = ₹ 20,000

Bonus Issue: 1:1
New lot size: 200
Adjusted Strike Price: ₹ 100
New Contract Value = ₹ 20,000

This adjustment ensures that neither the buyer nor the seller is at a loss due to corporate actions.

Role of SEBI and Exchanges in Adjustment Process 

The Securities and Exchange Board of India (SEBI) and stock exchanges like NSE and BSE play pivotal roles in managing the impact of corporate actions on F&O contracts. Their responsibilities include:

Their responsibilities include:

• Monitoring Corporate Actions: Keeping track of announcements that may affect F&O contracts.
• Calculating Adjustment Factors: Determining the appropriate changes to contract specifications based on the corporate action.
• Implementing Adjustments: Ensuring that all open positions are adjusted uniformly and transparently.
• Communicating Changes: Providing timely information to market participants about upcoming adjustments.

These measures help maintain market integrity and protect investors' interests.

Impact on Trading Strategy and Open Positions 

If you hold open F&O positions, corporate actions can impact your strategies in many ways:

1. Effect on Option Premiums 

Changes in strike prices and stock prices can cause large swings in option premiums. Traders must reassess their positions post-adjustment.

2. Effect on Margins 

A change in lot size may increase the total exposure and, consequently, the margin requirement.

3. Volatility and Liquidity 

Corporate events often lead to heightened volatility. Liquidity in the adjusted contracts may also reduce temporarily as traders reassess strategies.

4. Unhedged Positions Risk 

If you’ve entered a spread or hedge strategy, both legs may get affected differently, altering the risk-reward ratio.

Other Important Things to Know 

1. Adjustment Date

The contract adjustments usually take effect on the ex-date — the day the stock trades without the benefit of the corporate action.

2. Display on Trading Terminal 

Most brokers clearly show the adjusted strike prices and lot sizes in the trading platform, usually suffixed with a letter or code to indicate adjusted contracts.

3. Settlement Adjustments 

Settlement values (especially for options) are also based on the adjusted closing prices to ensure proper payoff calculations.

4. Tax Implications

Corporate actions can have tax consequences. For instance, receiving bonus shares may affect the cost basis for capital gains calculations. Or, receiving dividends can lead to tax liability since the amount is added to your total annual income and taxed as per your individual tax slab. 

Conclusion

Corporate actions are an unavoidable part of equity markets—and they directly impact futures and options contracts. As an F&O trader, it is crucial to understand how different events such as dividends, splits, or rights issues affect your open positions.

Thanks to regulatory frameworks by SEBI and stock exchanges, these adjustments are made in a systematic way to protect all market participants. Still, traders must be proactive in monitoring announcements and understanding how the adjustments will influence their positions.

Whether you're a beginner or an experienced trader, staying informed about corporate actions is essential for success in the F&O market.