Stock Splits and Consolidations

Q. And what happens if a stock splits? Is this reflected in your position?


A: A stock split is a means of changing the structure of the shareholdings in a company. It has no effect on the market capitalisation of the company and dilution does not occur since the share price is adjusted according to the terms of the split. It only increases the number of shares available for trading in a public company and if often done to improve liquidity in the underlying shares. Thus if a shareholder owns 1,000 shares of a UK company at £10 on the record date of the split, then his stake in the company will be worth £10,000. A 2- for-1 stock split would simply mean the investor owns 2,000 shares priced at 500p.

In spread betting stock splits are dealt with fairly too. In the event of a stock split the bets will be closed and opened again at a new price and stake which will take account of the stock split. You will not profit or lose as a result of the stock split. For instance, if Elan announced a 2:1 stock split and you had a £10 buy position at 2000 this position would be closed and a new spread bet would be opened for a £20 buy position at 1000.

Let's take another example -:

Suppose the shares were trading at 100. and you had a down bet of £10 per point.

The company then issues new shares for free on a 1 for 1 basis.

You could say that your spread betting provider will open a new bet at 0 in another £10 per point. Clearly you would be showing a huge loss on this position. On the other hand, you would be showing a huge profit on your prior position.

Imagine that the company had been worth £1,000,000 to start with - represented by 1,000,000 each worth £1. The issue of an additional 1,000,000 shares for no consideration has no impact on the value of the company. But as there are now twice as many shares in issue, they now trade at half the price: 50p. So, while opening a new down bet at 0 would generate a loss of £500, your prior down bet at 100 would show a profit of £500. So no net profit, but it's not very neat.

What the spread betting company actually does is to amend your bet. So where you were short £10 per point at 100, you would now be short £20 per point at 50. This may sound different, but in economic terms it is exactly the same. If the share goes to 0, your profit will be the same as before.

Q. I just wondered if you could confirm my understanding of spreadbets and dividends is correct. As far as I can tell you get no benefit of dividends in a spreadbet. The expected dividend seems to be excluded from the quoted price altogether, and so presumably does not drop when the share goes ex-div either. Have I understood this right?

A: Nope. I think it's fair to say without question spreadbets always include dividends (otherwise short positions would do extremely well).

Some don't always give you 90% of the dividend (after 10% tax rate) though.

To understand more it's worth noting the following:

Basically there are two types of spreadbet.

1. Daily Cash spread bet - automatically rolls over daily and will include adjustments as they happen (i.e. on ex-dividend day the price will be adjusted).

2. Quarterly Spreadbet - Spreadbet is priced to a certain date meaning that if there are any dividends (date of ex-dividend) occuring before the expiry then the price will account for that.

Effectively spreadbets are quoted ex-dividend (for any dividends due within the period for which the spread bet runs*), irrespective of whether the underlying stock is ex-dividend or not.

(* Therefore in the case of intra-day spreadbets the SB is cum-dividend until the x-dividend date of the share - as the share does not become x-dividend intra-day - the price of any rolled over daily bets is adjusted to account for the dividend overnight on the Eve of X-Dividend day).

So for example if a share price is £1.10 cum - dividend with a dividend of 10p. The spreadbet price would be £1.00 (plus any financing cost).

Once the share goes ex-dividend the share price (all else being equal) will fall by 10p to £1.00, the spreadbet price will not change.

So as a spreadbetter you do get the benefit of the dividend but you get it at the time of purchase (buying for £1.00 rather that £1.10) rather than by an actual transfer of cash to you once you hold the share.

(Things can though get a little more complex in the case of special dividends etc...)

This means that the dividend is reflected in adjustments to the opening price (on daily and quarterly bets). The only problem I've come up against is where a dividend changes or isn't known about when the current quarterly contract is set i.e. what happens if VOD suddenly declared they would return 10p to shareholders before the current June expiry - it actually might happen as well!

Two other situations sometimes arise:

1. In smaller companies, I sometimes find that the price quoted by the spread betting company doesn't reflect the details of a previously declared dividend; I normally either ask about this when I place the bet or when the share goes ex-div and I find the price quoted by the spread betting company has changed unexpectedly by the size of the dividend.

2. It is known that the share is almost certain to go ex-div, perhaps twice for bets expiring up to 9 months in the future, during the duration of the bet, but the exact details of the dividends can only be guest mated as they are yet to be formally declared.

Both the above situations can require adjustments to entry prices to correctly reflect the actual size of the dividends. My experience with spread betting a company is that they have always dealt with both these situations fairly rather than seeking to profit from them.

Q. What about consolidations? How are they accounted for?

Can you tell me what happens to my position if a company is going to consolidate its shares? For example, I open a position at 0.1 for 100 per pt, the company announces that its shares will be consolidated with a ratio of 100:1. The price will therefore increase 100x, will the spread betting company close my position on the day prior and reopen it on the following day at the new rate? If so what will be my stake and will that also get diluted?

If the contract had 4 months before expiry would the new one be for the same period? Would the company notify me before doing anything??

A: Let's go back to basics. In a share consolidation (sometimes referred to as a reverse split) the number of shares in circulation available to trade are reduced and the stock price adjusted upwards accordingly. The value of the company is not in any way affected. If a stock holder owns 1,000 shares of UK plc at £5 on the record date of the split, then his or her stake in the company is worth £5,000. A 1-for-5 consolidation would mean the investor owns 200 shares priced at £25 (implying the investor would still retain a holding equivalent to the £5,000). Consolidations are likely to be viewed more negatively by investors than stock splits as strategy consolidations are often linked with companies whose stock price is low because they are facing challenges. However, a consolidation may be necessary to remove the 'penny share' connotation tied to a particular stock.

To address your question, effectively you have answered the question in your email. If a company announces that its shares will be consolidated with a ratio of 100:1. The price will increase 100x, the spread betting firm will close your position on the morning of the ex date and reopen it at the new rate. Your stake will then decrease by 100x and therefore keeping the same risk on the trade.

If for example you had £100/p at a price of £1.00 and there was a 10 for 1 consolidation the provider would book off your original trade - flatten your original position at no cost and then rebook the trade with £10/p at a price of £10. The net position remains the same.

The contract period would also remain the same. You would not necessarily be notified before the amendment took place but usually the spread betting company will contact you via telephone or e-mail detailing the changes that have taken place to your position.

In general terms; if a stock consolidates, if a company announces a rights issue, if a dividend payment is increased or decreased, if a company is wound up and cash is paid out in lieu of shares held on a spread bet, the holder of the open position via a spread bet will receive the exact same entitlement as a fully paid up shareholder. This is because the position will be hedged with a CFD which in turn is hedged with the underlying equity and all benefits are passed on. The only benefit not passed on is shareholder voting rights as the holder of the position as a spread bet is not a registered holder of the stock.

Q. I have a long spreadbet on SCHE, which seems to be attracting rumors of a possible takeover...

I am wondering, if the takeover was announced at, say, 40p, then would the spread betting company honour this or is there some silly clause that takeover's are exempt? I don't know why this would be the case, but just cautious of the games they seem to play. Sorry, sounds silly, but I am very sceptical of spread betting companies (especially CMC!) but then again, this is with another company, not CMC!

A: Yes, unless you are dealing via some dodgy provider, I would expect the spread betting firm to honour the bet in the event of a news related price surge. They do so every day. (are you in a position to honour your side of the bet if the share price collapses??).

However there is always a risk that a major announcement (of a takeover or whatever) might be accompanied by some connected corporate action such as the issue of additional shares or a change in the status of existing ones - or a suspension of trading that runs on beyond the expiry date of your spreadbet. You also need to be sure that on smaller stocks you haven't opened a bigger bet than can be readily closed if the market in that stock tightens.

 ...Continues here - Rights Issues and Stock Suspensions

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