Trading Options Around Stock Splits & Buybacks: What the Market Isn’t Pricing In

Stock splits and buybacks are often seen as routine corporate events—but for options traders, they can signal a hidden edge.

This article explores how traders can anticipate and exploit pricing inefficiencies in the options market before and after events like stock splits and share buyback announcements. A lot of the time, these moves are done by companies to deal with expansion or contraction, but there are instances where they are done more from a standpoint of public relations. No matter the reason, these are great opportunities for traders to gain a hidden edge.

In this guide, you will learn how to structure trades around these events, avoid pitfalls, and recognize when the market may be underestimating the impact. You can stay a few steps ahead of the markets before they can fully take in what has happened and ride the wave or mispricing to a profitable end!

Understanding Stock Splits & Buybacks

Stock splits and buybacks can signal some profit opportunities for online traders and investors, although it can seem like a routine event from the standpoint of the companies that are either upping the number of shares or decreasing them. As we talk about the nature of stock splits and buybacks, you can learn more about how contract adjustments work and how this can have an impact on traders psychologically. Plus, there are profit opportunities to be had amid the noise with increased volume and volatility on these stocks.

What Is a Stock Split?

Stock splits occur when a company increases the number of available shares for a certain stock while also reducing the share price based on the larger number of shares that are now out there for traders to buy or sell. The most common type of split is what’s known as the “forward split,” where there is a 2-for-1 exchange. For every one share that a trader owns, they get two new shares, but the price per share will be cut in half. One of the key ideas behind the stock split is that the traders or investors don’t lose out in value, but the number of shares they own will change, along with a proportionate change in the value per share.

Reverse Split

The reverse stock split is the exact opposite of the forward split. In this case, the company might be contracting and therefore reducing the number of shares that are available to investors. The typical reverse split is taking every two shares that a trader owns and combining them into one, but doubling the price for that single share. Reverse splits decrease liquidity, which makes it more expensive for traders and investors to purchase those stocks and harder for them to sell when the time comes.

• Contract Adjustments: When there are stock splits or buybacks, the options keep their notional value, and this is done through a system of contract multipliers and deliverables. These pricing dynamics can shift a lot of the time, opening the door for eagle-eyed investors to make their move and exploit these mispricings. It’s usually the case with contracts that are either high-volume or near-the-money.
• Psychological Impact: After a stock split, there can be lower nominal prices that can greatly attract new investors or traders, and it’s all under the perception of affordability. This psychological impact can result in a higher level, volume, or volatility with these stocks, but the fact of the matter is that the company’s value remains the same, even though it doesn’t seem like it on the surface.

What Is a Share Buyback?

Share buybacks occur when the company buys back its own stock from the open market. They can also make this happen through a tender offer, which is a public offer to buy shares of a company at a premium above the current market price. Tender offers are bought directly from the shareholders. When companies repurchase shares from the market like this, it results in reduced float, and it can increase the earnings per share (EPS).

When there are share buybacks, this can usually be a great sign for a company as it can be a strong sign of management confidence and it provides long-term price support. There is a secondary effect where analysts and institutions might do a rerating for the stock because the buyback is a positive financial signal for the company that is performing them.

Why These Events Matter to Options Traders

Stock splits (forward and reverse) and buybacks are two market events that have nothing to do with the fundamentals of the stock at hand, but they can have a huge impact on market sentiment, volatility, and liquidity in the options markets. They can provide traders with prime opportunities for securing a profit.

• Price Revaluation Effects: Changes in share price can influence volatility and liquidity as traders will usually front-run a price movement. This can occur without any real change in the value of the stock. This is where you see an increase in volatility or volume, and it has nothing to do with changes in notional value.
• Sentiment-Driven Movement: You typically see this with some of the better-known stocks, where retail participation often spikes after split announcements. Some good examples of this can be seen with companies like Apple, Amazon, or Tesla. Volume will increase during these times where there are splits or buybacks, and this can have a big impact on mispricings.
• Volatility Patterns: Implied volatility (IV) may remain mispriced during quiet periods leading up to these announcements. This IV distortion can offer mispricings that can benefit buyers and sellers alike. However, which way the mispricing benefits either party ultimately comes down to timing.

Hidden Market Inefficiencies

Hidden market inefficiencies refer to scenarios where an asset’s price doesn’t accurately reflect its true value. This might be due to elements in the options market that aren’t readily apparent.

Stock Splits

During a forward stock split, you usually see a short-term increase in stock prices because traders are reacting positively to the idea that the company is offering more options to meet the demand of interested traders who want to participate in the markets. You’ll see the following occurrences in the market as traders react to this change in the number of shares and their individual valuation:

• Lag in Momentum: Options chains may lag in pricing the momentum the stock experiences after the split, so the value might not always be reflective of the short-term increase as traders scramble to participate.
• Volatility Compression: While there is the possibility for increased IV in the short-term after a stock split, it is typical to seeIV go on the wane over the long-term, and this presents a prime opportunity for premium-selling strategies. For instance, traders could embrace strategies like selling covered calls, selling cash-secured puts, or iron condors/butterflies.

Example

A good way to illustrate the effect that a stock split has on the trading action that happens afterwards is to look at Apple’s (AAPL) historical IV behavior around past splits. There was a notable split in 2020, which was a 4-for-1, where the IV levels were really high going into the split following the initial announcement. There was a rapid drop-off in IV following the split itself, and this presented an excellent opportunity for savvy traders to use profit strategies like an iron condor or a straddle to make money from the volatility.

Buybacks

Buybacks can be interpreted as a sign that a company has extra cash flow to buy back shares because they feel like they’re being undervalued. In addition to traders seeing this as a positive occurrence and the stock price going up in the short-term, there are several other effects that a buyback announcement can have on the stock price and the markets:

• Mispricing for IV Before News or Catalyst: When a company announces that it’s going to be doing buybacks, this can trigger an unexpected spike in IV that can lead to certain stocks being mispriced. These discrepancies are most likely to happen when it’s in line with macro catalysts and earnings reports.
• Underappreciated Impact: A second wave of opportunity can arise when EPS improvements aren’t always priced in properly. The market often underprices gradual EPS and float impact—the underappreciated impact can provide a ton of opportunities for traders who are paying attention to these buybacks.
• Drift That Occurs After the Buybacks: There can be under-the-radar uptrends following execution, known as the post-buyback drift. These gradual uptrends typically occur when certain stocks have large buybacks as a result of institutional accumulation and a reduced supply begins to kick in.

When it comes to buybacks, there is the chance for traders to not initially react to the announcement, and the market experiences a quiet period going into the buyback. After it is complete, there is the chance for IV spike post-news.

Strategy Ideas—How to Trade Around These Events

Now that you’re familiar with how stock splits and buybacks can influence the market dynamics, let’s dive into some of the best strategies you can be using to trade around these events, making the most of the situation to come out ahead!

In this section of the guide, we’ll be discussing a way you can profit by using strategies that take place before the split even occurs and a method where you’re focusing on the events following the split’s occurrence. We’ll also touch on a trading move that’s centered on buybacks and the accumulation drift that is characteristic of this environment.

Pre-Split Momentum Play

There are a few good trading techniques that investors can use where they take advantage of the momentum the market is experiencing before a stock split. It’s key for traders to make their move before the split happens to take advantage of the volatility and volume that is pushing the price upward during this time.

• Setup: A long call debit spread or diagonal call spread can be used when traders have a moderate bullish outlook on the underlying asset they’re trading. Each strategy involves buying and selling call options, and traders initiate these trades through a net debit.
• When: It is best to initiate these strategies right after the stock split announcement, but before the execution date. The sweet spot is the time in between, and they work so well because traders are feeling bullish about the future of the stock. They’re riding the momentum from the announcement, but they’re avoiding the dropoff in value following the execution.
• Why: Sentiment and volume push often boost near-dated OTM calls. This time between the announcement and execution is perfect because the market is more liquid than ever, and the value of the stock is up due to positive market sentiment and increased trade volume. Traders need to exit their long call debit spreads or diagonal call spreads before the stock split occurs, before their trade becomes unprofitable.

Post-Split IV Fade

Following every stock split, there is the expectation that there will be a decrease in implied volatility after the type of activity around the stock split begins waning. It is similar to when the uncertainties and volatility around an earnings report begin dissolving away once the report has been made public.

• Setup: So long as liquidity permits, traders could use either an iron condor or short straddle to take advantage of the post-split IV fade. The iron condor can benefit from decreasing IV because it can lower the cost to buy back the sold options, which can ultimately increase profits. Both risk and reward are well-defined, which can make it a good option for traders who are working with a limited amount of money or want to know ahead of time what the parameters of the strategy are. On the other hand, you have the short straddle, which benefits from a decrease in IV, which makes it a great option for the time following the stock split and the accompanying IV fade.
• When: After the split execution is the best for either the iron condor or the short straddle because this time is marked by elevated IV that is getting ready to trend down. Both moves benefit from decreasing IV (the condor increases in profitability, and the straddle also benefits from the dropoff).
• Why: Price stabilizes following the stock split as interested investors begin to decrease because the hype around the stock split is coming down. There is also theta decay, which accelerates and causes these strategies to do well. Theta decay erodes the value of the short option in the iron condor, leading to a more profitable scenario, while it erodes both the short call and put options in the straddle to the benefit of the trader.

Buyback Accumulation Drift

This phenomenon is the tendency for a stock price to go up in value over time after a company goes out of its way to buy back its own shares in an attempt to fix a misvaluation. Let’s look at a few setups for making money off this occurrence and the right timing that traders need to get down to make these strategies work to their benefit.

• Set up: Put credit spreads or long delta strategies are both good strategies to use when dealing with accumulation drift as a result of a buyback. Put credit spreads are where a trader sells a put with a higher strike price and buys a put with a lower strike price—they get a net credit from this trade. The outlook of this move is bullish and aims to profit from the stock staying at a higher strike or moving up further than that. Long-delta strategies are a good fit for buyback accumulation drift because they increase in value when the underlying stock price goes up.
• When: The best time to use the put credit spread or the long-delta move is right after confirmed buyback plans, especially with undervalued stocks.
• Why: Reduced float supports a slow upward drift, especially in low-volatility names. When a company is doing consistent buybacks, this can create a floor under the stock price, which makes it less likely to fall off in value considerably. This is what makes put credit spread and long-delta strategies so ideal for buyback accumulation drift.

Risk Considerations

Stock splits and buybacks tend to be useful actions for companies to deal with a growing business or contracting performance, but traders should be aware that there are some significant risks at hand with each of these market events. It is key for them to evaluate each situation based on their ultimate trading strategy as well as the fundamentals of the companies whose stocks they’re trading.

• Uncertain Timing: Not all splits/buybacks are announced clearly in advance, as companies have different disclosure requirements. Some companies have more leeway in their decision to announce these events, so the timing of splits or buybacks can create a lot of uncertainty for traders who want to get the timing right.
• Traders Getting the Timing Correct: Some people can make the mistake of entering trades around a buyback or a stock split when the stock is overvalued, and this can lead the trader to get poor returns. They need to consult historical stock performance for a sense of a good low point that would make for the best entry.
• Market Conditions Override: A bearish macro environment can offset a bullish buyback effect, which results in lackluster returns for the trader. There can be a lot of factors at play that can lead to these bearish conditions, like investor confidence being low or a declining corporate event that can bring the stock price down, making it difficult to turn a profit with a bullish buyback.
• Liquidity Challenges: Traders can run up against the challenge of finding it difficult to buy or sell the stock they’re dealing with in an efficient manner, especially for newer or smaller stocks post-split. When it comes to buybacks, the smaller number of shares available can create a similar problem for those investors.
• Contract Adjustments: Complexities in strike prices post-split need close attention by traders because there is the possibility of these adjustments causing reduced liquidity and increased volatility, which could have a big impact on the trade.

Real-World Examples

How do some of these strategies around stock splits and buybacks play out in the real world? Check out some of the real-world examples we have provided so you can have a deeper understanding of how these strategies are structured and get a sense of the timing needed to make them profitable.

• Stock Split: A good example of trading around stock splits from the real world happened in 2020 when Apple (AAPL) had a 4-for-1 split. IV rose from ~30% to over 50% leading up to the split, but it didn’t last long because that IV dropped off severely right after the split happened. The big price rally followed by a big decrease in IV would have been a good time for traders to do some premium selling.
• MSFT (Microsoft) Buybacks: Microsoft is a company that is well-known for its steady programs of repurchasing its own stock to ensure that the valuation is accurate. These repurchase programs often coincide with long-term price strength and favorable skew setups.
• Buybacks for LMT (Lockheed Martin): Another good insight into buybacks and how certain companies operate is seen with Lockheed Martin, a company that is well-known for initiating buybacks after earnings. It is often followed by quiet but persistent accumulation trends.

Tools & Resources

To trade dynamically around events like buybacks or stock splits, traders can use the following tools for great insights into what might be going on behind the scenes. Some of the tools also provide information on known events that could have a bearing on the stock price. Check out these must-have trading tools to make the most of these profit opportunities!

• SEC Filings: Traders can use these resources to gain insights into buyback approvals for certain companies. It is key to focus on those with 10-Ks or 8-Ks. Traders should also check out earnings call transcripts for official confirmation of buyback disclosures.
• Earnings Calendars: A lot of the time, buybacks and splits will coincide with earnings report releases or announcements. Traders can use the earnings calendar as a rough guide for when a potential buyback or split is to occur, and they can plan their strategy accordingly in the downtime.
• Options Tools: In addition to using a reputable, trustworthy broker app, options traders will need to use some backup options tools for the best results. For instance, OptionStrat is a decent product for visualizing the profit and loss profiles for different strategies. Then you have a tool like Market Chameleon, which is terrific for scanning historical volatility and viewing IV rank or IV skew.

Take Advantage of These “Boring” Market Events

Stock splits and buybacks present unique trading windows that many market participants overlook. Traders can use either of these events to ride the sentiment wave that comes from increased investor confidence, or they can trade around misplaced volatility. Either way, traders with a keen eye can use splits or buybacks as a way to benefit from an edge that the broader market doesn’t see and turn a profit in the process!

Final Thought: The real edge lies not just in the news, but in how and when you position yourself around it.