Adjustments for Corporate Actions

Corporate actions are events initiated by a listed company that affect the rights, ownership or value of its securities. They are announced through a formal circular and become effective on a specified record date. For equity derivatives, the underlying security’s market price, face value or share count may change, and the exchange must modify the contract terms to keep the derivative fair for both buyer and seller.

SEBI mandates that any change which alters the economic exposure of a derivative holder must be reflected in the contract specifications. Failure to adjust would create arbitrage opportunities and could distort the price discovery process on the derivatives platform.

In the NISM exam, questions often present a corporate action and ask how the futures contract size or option strike price will be altered. Remember: the adjustment is purely mechanical – it does not depend on market sentiment, only on the change in share structure.

• Adjustment maintains the same monetary value of the position before and after the action.
• The exchange publishes the revised specifications on the ex‑date.

Stock Split – The company increases the number of shares by issuing additional shares for each existing share, e.g., a 2‑for‑1 split. The face value per share falls proportionally, but the total market capitalisation remains unchanged.

Bonus Issue (Scrip Issue) – Free shares are allotted to existing shareholders in a fixed ratio (e.g., 1:5). No cash changes hands, but the share count rises, reducing the price per share.

Rights Issue – Existing shareholders receive the right to buy new shares at a discount to the market price. The issue price and the subscription ratio determine the adjustment factor for derivatives.

Dividend – Cash dividends reduce the share price on the ex‑date (known as the dividend‑adjusted price). Stock dividends (bonus) are treated like a bonus issue.

Mergers, Acquisitions & Spin‑offs – When two companies combine or a subsidiary is carved out, the underlying share may be replaced by a new security. The exchange defines a conversion ratio to adjust contracts.

A stock split changes the face value of each share while keeping the total equity unchanged. To preserve the economic exposure of a futures contract, the exchange multiplies the contract size by the split factor and divides the strike price by the same factor.

The split factor, also called the Adjustment Factor (AF), is calculated as the ratio of the old face value to the new face value. Because the market price per share moves in the opposite direction, the product of contract size and strike price remains constant.

Exam questions often give the old and new face values and ask for the revised contract size or strike price. Remember the two‑step rule: size × AF, strike ÷ AF. This ensures that the total contract value (size × strike) is unchanged.

A bonus issue adds free shares to each shareholder in a fixed ratio, e.g., 1 bonus share for every 5 held (1:5). The adjustment factor is calculated as:
AF = Old Face Value ÷ (Old Face Value + Bonus per Share). The contract size is multiplied by AF and the strike price divided by AF.

Because the bonus shares are issued at zero cost, the total market value of the holding remains the same; only the per‑share price adjusts downward.

In the exam, the bonus ratio is usually given as “x bonus shares for y existing shares”. Convert this to a per‑share bonus amount before applying the formula.

A rights issue gives existing shareholders the right to purchase additional shares at a pre‑determined price (rights price). The adjustment factor is: AF = (Old Face Value) ÷ (Old Face Value + Rights Price × (Rights per Share ÷ Existing Shares)). The exchange uses the same AF for contract size and strike price.

Because the rights price is usually lower than the market price, the adjusted strike price will be lower than the pre‑rights price, reflecting the cheaper acquisition cost.

For NISM, you will most likely see a simplified version where the rights ratio and issue price are given, and you are asked to compute the new strike price directly using the AF.

When a cash dividend is declared, the underlying share price drops by the dividend amount on the ex‑date. Futures and options contracts are adjusted by reducing the settlement price by the dividend per share. Contract size and strike price remain unchanged.

In a stock dividend (bonus issue), the adjustment follows the bonus‑issue methodology described earlier – both contract size and strike price are altered.

Exam focus: Identify whether the dividend is cash or stock. Cash dividend → only settlement price adjustment; Stock dividend → full split‑type adjustment.

During a merger or acquisition, the original shares may be replaced by shares of the acquiring company at a pre‑announced conversion ratio. The exchange publishes a conversion factor that is applied to the derivative contract’s size, strike and settlement price.

Spin‑offs involve separating a subsidiary into a new listed entity. Holders receive shares of the new company in proportion to their existing holdings. Derivatives on the parent stock are adjusted using the spin‑off ratio, while new contracts may be introduced for the spun‑off entity.

For the NISM exam, remember that the adjustment is always a simple multiplication or division using the ratio supplied by SEBI/Exchange; no complex valuation is required.

SEBI (Securities and Exchange Board of India) mandates that the exchange must publish the revised contract specifications on the ex‑date of the corporate action. The adjustment is effective from the opening of trading on the ex‑date, and the previous specifications cease to apply.

The guidelines specify that the adjustment factor must be calculated using the face value ratio for splits and bonus issues, and using the rights issue price for rights issues. For cash dividends, the adjustment is a simple subtraction of the dividend per share from the settlement price.

In the exam, a question may ask for the “effective date of adjustment” – the answer is always the ex‑date, not the record date or announcement date.