Understanding the Current Stock Split Craze
On July 30th, Apple announced a 4-for-1 stock split. On August 31st, an investor who currently has 100 shares of Apple would end up with 400 shares of Apple.
To quickly clarify, you don’t gain or lose money from a stock split. Companies don’t become more valuable because of a stock split.
If today’s shares reach $500 on August 31st, an investor’s 100 Apple shares at $500 per share would turn into 400 shares priced at $125 per share.
Tesla proceeded to announce a 5-for-1 stock split on August 11th in what can soon become a wave of stock splits from big tech.
But since a stock split doesn’t affect a company’s overall value, and shareholders end up with the same money, why do companies still do splits?
Splits appear to make even less sense on the surface when you factor in fractional trading. Lowering the price of shares makes them more affordable, and this made much more sense at the start of the 21st century.
However, you can start investing in Apple and Tesla for as little as $1. Why do splits still happen then, and what do they mean for investors?
The FOMO Surge
Anytime a big company announces a stock split, they get the national spotlight. We’re talking about Apple and Tesla stock because they announced their splits.
A lot more people are paying attention to those two stocks and trying to get in before the split takes place.
In the past two days since announcing the 5-for-1 stock split, Tesla has surged by almost 20% and is challenging all-time highs.
Apple is also up close to 20% since the company announced its 4-for-1 stock split, but their growth comes at the same time as a stellar earnings report. Tesla on the other hand announced their stock split a few weeks after releasing their latest earnings report.
Investors don’t want to miss out on the split, and they’ll gobble up as many shares as they can prior to the split. As more investors see the stock rise leading up to the stock split date, more investors will pile on, fearing that they’ll miss out on further gains.
There’s also a big of ego involved. It feels better to say you have 100 shares of Apple post-split than only 25 shares of Apple pre-split.
Do Stock Splits Even Matter Anymore?
Stock splits tend to generate a mania of excitement before the stock split date and then slow down a bit once the split is completed. The short-term uptick can be enough for certain executives to receive their bonuses if those bonuses are tied to market cap and overall stock performance. However, I don’t think that’s the main motivation in either of these cases.
It’s easier for an investor to get a whole share of a company rather than a fractional share, and while this will stroke investors’ egos, you still own the same percentage of the company.
BUT…there is one group of investors that will happily welcome a stock split that makes each share easier to buy…the options traders.
Unlike stocks, you currently can’t buy or sell fractional options, and the more expensive the stock, the more expensive the option.
Options give you the right to buy or sell 100 shares of a company at a certain strike price.
Currently, if you want the right to buy 100 Apple shares at $465 per share anytime before the September 18th expiration date, it would cost you $1,987 to get that call contract.
Even though you may only see 19.87 instead of the $1,987, that 19.87 is the premium per share. Since all options contracts involve 100 shares, that 19.87 becomes a $1,987 premium.
If the stock split already happened, those same numbers would look like this:
Strike price of $116.25
Premium of $4.97 per share ($497 to buy the call contract)
That’s more affordable for an investor getting started with options. The lower stock price also makes it easier for covered call investors to accumulate 100 shares of Apple.
In a covered call, you own 100 shares of a company. To earn some extra money, you sell a call that gives someone the right to buy your 100 shares at a certain strike price.
For the $465 example, you would make an upfront $1,987 premium with a covered call rather than being the person who pays that premium. In return, the person with the contract can buy your shares at $465/share at any point before September 18th.
While this severely limits your upside in the likely event Apple stock continues to march on, it does give you an instant upside of 4.3% return on your investment in 1 month’s time (Apple is currently $461.64 per share as I write this). If an investor buys your shares at $465 per share, you would also receive the capital gains ($465 — $461.64 = $3.36/share; an extra $336 on top of your $1,987).
If Apple’s stock stays below $465 per share, you get to keep the shares and the premium. You can do the covered call all over again.
However, to buy 100 shares of Apple which is required to sell a single covered call, you’d have to find $46,164 to invest. If the split already happened, you’d only have to find an extra $11,541 to buy 100 shares for your covered call. While still a big number, it’s far more manageable.
To sell a single covered Tesla call, you’d need to find an extra $162,758 and put it all in Tesla (their current price is $1,627.58 as of writing this article). If the stock split had already happened, you would have only need to invest $32,551.60 to assemble your 100 TSLA shares for a covered call.
For most people, stock splits don’t matter. They’re just an ego booster because you can say you have a higher quantity of shares. For option traders, the upcoming Apple and Tesla splits make it easier for them to start call and put positions for those companies. And even if you could afford the $162,758 required to buy the 100 Tesla shares for a covered call, that $162,758 into one stock makes it very difficult to diversify the rest of your portfolio.
Will More Companies Follow?
Apple and Tesla have taken the investing world by storm with their stock splits. While many companies can use a stock split based on their current prices, Amazon and Alphabet are the two companies that get brought up the most.
Amazon’s stock price sits above $3,000 while Google’s stock price sits at the more “reasonable” $1,500 range. Stock splits from these companies would result in a surge of new investors and more options traders getting the chance to buy and sell options of these respective stocks.
With Apple and Tesla both announcing stock splits, there’s a stronger focus on stock prices. All eyes are set on those two companies to see if they will announce stock splits in the near future.