Splitting Shopify May Be a Boon to Options Traders

By now you almost assuredly know that Shopify (SHOP.TSX) announced a 10:1 stock split effective on a date to be announced.  With that announcement, SHOP joins Alphabet and Amazon in the club of internet stocks with high prices and pending stock splits.

Although news of a stock split is generally considered a positive, let’s be clear – stock splits have no bearing on a corporation’s business or balance sheet.  They are the equivalent of making change.  You give me a $10 bill and I give you back 10 loonies.  There are differences in utility to having different denominations of currency – one person may prefer to have change for small purchases or tips, while another may prefer to have a thin wallet – but the amount of each person’s wealth is unchanged after a transaction of that sort.  In this case, if you own 100 shares of SHOP valued at $750 each just before the split, you will have 1,000 shares of SHOP valued at $75 each when it opens after the split.  Either way, they are worth $75,000. 

Markets believe that the utility of a lower share price exceeds that of a higher one.  A phrase we have heard many times is that the split will make the stock more accessible to individual investors.  That was certainly the case when stocks traded almost exclusively in round lots of 100 shares each but that has not been the case for quite some time.  The concept of odd-lot vs. round lot has largely vanished over the years.  Furthermore, the advent of fractional share trading^[1]  largely removed any barriers to entry for those who want to get exposure to the stocks of even the most expensive companies.  That assertion is appealing, but not necessarily accurate in the current market environment.

That said, options on SHOP are likely to become far more accessible to individual traders.  When a stock splits in Canada, the Canadian Derivatives Clearing Corporation (CDCC) adjusts the options prices to reflect the split.  If you own one contract of the $750 strike calls on the date of the split, you’ll have 10 contracts of the $75 strike calls one day later.  All things being equal, the price of those options will be 10% of what they were pre-split.  This has a profound effect on the affordability of options.  Remember, the smallest available increment of options is one contract that reflects 100 shares of the underlying stock.  As I type this, the SHOP $750 calls expiring on May 20th are about $84 per contract.  One contract would therefore cost about $8,400.  If the split were miraculously to occur right now, the resulting $75 strike calls would be priced at roughly $8.40 per contract.  That means that the minimum outlay for that call would now be $840, or 90% less. 

With a minimum cost of entry that will be 1/10th of what it is currently, the options will indeed be more accessible to small traders.  Even better, spreads should decline markedly.  The current spread on the $750 strike options discussed above is $4.  Simple math would imply that the spread would shrink to 40 cents, but I would not be surprised to see the spread shrink to something even tighter.  If the options are more accessible to smaller traders, it would imply that liquidity would improve.  More liquid markets tend to have narrower spreads.  For example, options in BCE Inc. (BCE.TSX) with a similar relative price and time to expiration have spreads between 10 and 20 cents. 

Bear in mind that the spaces between strikes is also likely to shrink commensurately, at least initially.  SHOP typically has strikes in $10 increments.  By definition, the options affected by the split will shrink to a $1 increment by necessity.  

While it is entirely possible for reasonable people to disagree whether a stock split truly makes a stock like SHOP meaningfully more affordable to individual investors, it appears quite certain that a split can indeed make a stock’s options profoundly more affordable to individuals.

^[1] Fractional shares are available at Interactive Brokers Canada, an affiliate of the author’s employer, though not at all brokers in Canada.

The author of this article is a senior officer of an affiliate of Interactive Brokers Canada Inc. (IBC), an approved participant of the Bourse de Montréal Inc. (MX) and a clearing member of the Canadian Derivatives Clearing Corporation (CDCC). Nothing in this article should be considered an investment or trading recommendation by IBC or any of its affiliates. Trading in options  is highly speculative in nature and involves a high degree of risk. Before trading options listed on the MX and issued by the CDCC, one should read and fully understand the current CDCC disclosure document entitled “The Characteristics and Risks of Listed Canadian Options”. Trading of certain standardized Canadian Listed Options may not be permitted for U.S. Residents. To receive a copy of the CDCC disclosure document referenced above call 877-745-4222 or copy and paste this link into your browser: https://www.cdcc.ca/f_en/Options_Disclosure.pdf

Disclaimer:

The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.

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