Bonus Issue Adjustment in Futures and Options Contracts
On Tuesday, 5 August, Alpha Ltd (cash price ₹1,480) announces a 1:1 bonus, with record date Wednesday, 20 August and ex-date Tuesday, 19 August. Alpha's August stock futures, lot size 400, last traded at ₹1,502; the 1,500-strike August call is the most active option.
One client holds 6 lots of the 1,500-strike August call sold at a premium of ₹38, and 4 lots of August futures long as a partial hedge. Another client sold 2,000 Alpha shares in the cash market on Monday, 18 August, settling on 19 August, and now expects to receive the bonus. A third client has 1,200 Alpha shares pledged with the broker as collateral.
The exchange announces an adjustment factor of 0.5 with effect from the ex-date. The operations desk must adjust every contract before the market opens on 19 August and answer three client queries.
1. State the adjusted contract specifications - futures price, lot size, option strike and the hedge client's position. Show the calculations.
Read the worked answer
The adjustment factor of 0.5 is applied to prices and strikes, and its reciprocal to the lot size, so that the economic value of a contract does not change on the ex-date.
- Futures price: ₹1,502 × 0.5 = ₹751.00
- Futures lot size: 400 ÷ 0.5 = 800
- Option strike: ₹1,500 × 0.5 = ₹750, rounded to the nearest permitted strike per the exchange's methodology (ticks are typically finer than ₹1, so check the notified adjusted strike rather than assume)
- Option lot size: 400 → 800
- Hedge client's position: 4 long futures lots of 800 = 3,200 units (unchanged from 4 × 400), and 6 short calls of the 750 strike, 800 units each = 4,800 units (unchanged).
The trap is to adjust only the price and forget the lot size, or to adjust the lot and leave the strike at 1,500 - either error changes the contract's notional and breaks the hedge. Positions are adjusted, not squared off: no client consent is needed, but the adjusted contract note/statement must be issued and the demat-side bonus entitlement tracked separately.
2. The hedge client argues that because his lot size has doubled, he now carries a much larger position and should get extra margin benefit. Explain whether his quantity changed and how margin should be recomputed.
Read the worked answer
His economic quantity has not changed. Before adjustment he held 4 × 400 = 3,200 futures units and 6 × 400 = 2,400 call units; afterwards he holds 4 × 800 = 3,200 units and 6 × 800 = 4,800 units of a contract whose strike is now ₹750. The number of units and the rupee notional (about ₹1,502 × 3,200 ≈ ₹48.06 lakh before, ₹751 × 3,200 ≈ ₹24.03 lakh after - roughly half) tell the real story: the share price itself halves, so the position's notional falls even though the lot number rises.
Margin must be taken from the exchange's adjusted parameter file, not computed internally. The exchange recomputes VaR, extreme loss margin and the client-level margin on the adjusted price and lot, and the broker's risk system must consume that file on the ex-date morning. Hedge benefit at the client level is preserved because both legs were adjusted by the same factor, but the rupee margin will fall roughly in proportion to the price.
So the correct answer to the client is: your hedge is intact, you are not carrying a larger exposure, and no additional margin benefit arises from the doubling of the lot size. What he should watch is that any hedge where one leg was a cash position or a different expiry may no longer offset after adjustment - those must be reviewed individually.
3. Which of the two remaining clients is entitled to the bonus shares, and what must the broker verify about the pledged shares?
Read the worked answer
Bonus entitlement. Under T+1 settlement, a trade on Monday, 18 August settles on Tuesday, 19 August. The buyer therefore becomes the registered holder before the record date of Wednesday, 20 August, which makes 18 August the last cum-bonus day and 19 August the ex-date. The client who sold 2,000 shares on 18 August delivers 2,000 shares and receives no bonus; the entitlement belongs to the buyer. If the broker's back office credits him 2,000 bonus shares by mistake, it is the broker's loss to recover, and the client should be told clearly before he transacts on the assumption of a windfall.
Pledged shares. The 1,200 shares remain 1,200 shares of record, with the bonus shares being credited separately in the depository. The broker must, on the ex-date, pull the depository statement and confirm whether the bonus quantity is covered by the existing pledge or has been credited free in the client's account. If it is free, the broker should not count it as collateral and should obtain a fresh pledge instruction from the client. It should also revalue the collateral at the adjusted price with the applicable haircut, and check that the client's collateral margin requirement is still met after revaluation.