General Securities Representative (Series 7) Practice Exam

During a reverse even or odd stock split, which of the following increases?

1. Shares per contract

2. Strike price and premium

3. Number of contracts

4. Underlying stock value

The correct answer is: Strike price and premium

In a reverse stock split, companies consolidate their shares, which means that shareholders receive fewer shares for each share they own, while the overall value of their investment remains the same. During this process, the strike price of options and premiums associated with those options increase in direct relation to the reverse split ratio. For instance, if a company executes a 1-for-2 reverse stock split, the number of shares held by a shareholder is cut in half, but the price per share doubles. This means that the strike price for options reflecting the underlying shares must also double to correspond with the new share price. Similarly, the required premium that option buyers must pay also rises, since the value of each contract reflects the higher price of the stock. Therefore, as the outstanding shares decrease and the price per share increases, the strike price and premiums for options must adjust accordingly, leading to an increase in these items during a reverse stock split. This highlights the relationship between the underlying stock and its associated options in such corporate actions.