Corporate Action Adjustment (Derivatives)
Corporate action adjustment in derivatives refers to the process by which the exchange and clearing corporation modify the strike prices, lot sizes, and contract values of existing futures and options contracts when the underlying stock undergoes a bonus issue, stock split, rights issue, or special dividend, to ensure continuity of economic exposure for position holders.
When a company announces a corporate action—a bonus issue, stock split, amalgamation, rights issue, or extraordinary dividend—the price of the underlying equity share changes on the ex-date to reflect the action. Without a corresponding adjustment, open futures or options positions would experience an artificial gain or loss unrelated to market movement, simply because the share price changed due to the corporate action rather than market dynamics.
For stock futures, the adjustment is straightforward. If a stock announces a 1:1 bonus issue, its ex-date price will theoretically be half the cum-bonus price. NSE and BSE adjust the futures contract by halving the futures price and doubling the lot size so that the total notional value of a position remains unchanged. The open interest also adjusts accordingly. Position holders neither gain nor lose economically from the adjustment itself.
For stock options, the adjustment is more complex because it involves modifying multiple contract parameters. The exchange typically adjusts the strike price proportionally (dividing by the adjustment factor for a bonus or split) and adjusts the lot size in the opposite direction. For example, a 2:1 bonus on an options contract with a strike of Rs 1,000 and a lot size of 500 would result in adjusted contracts with a strike of Rs 667 and a lot size of 750 (approximately). Rounding rules and minimum lot size requirements can cause minor practical complications.
For rights issues and special dividends, the adjustment methodology is prescribed by SEBI through exchange circulars. Ordinary dividends do not trigger adjustments because they are built into the futures pricing model through the cost-of-carry framework—futures prices already reflect expected ordinary dividends. Only 'extraordinary' dividends above a specified threshold trigger formal contract adjustments.
Position holders are notified of corporate action adjustments through exchange circulars published well in advance of the ex-date. Adjustments are made at the clearing corporation level overnight on the ex-date, ensuring that when the market opens the next morning, all open positions reflect the adjusted parameters. Traders must account for these adjustments in their risk management systems and position-tracking software.