Stock splits are one of the most exciting corporate events for traders. When a company announces a split, the stock often moves significantly both before and after the event. Understanding how to trade these events can give you an edge in the market.
What is a Stock Split?
A stock split is when a company divides its existing shares into multiple new shares. The total value of your investment stays the same, but you own more shares at a lower price per share. Companies typically split their stock when the share price gets too high and they want to make it more accessible to retail investors.
Key concept: In a 4-for-1 split, if you owned 10 shares at $400 each ($4,000 total), you would now own 40 shares at $100 each (still $4,000 total). Your ownership percentage and total value remain unchanged.
Why Companies Split Their Stock
There are several reasons why companies announce stock splits:
- Accessibility: Lower share prices allow smaller investors to buy whole shares
- Liquidity: More shares outstanding can increase trading volume
- Psychology: A lower price can make the stock seem more affordable, even if the value is the same
- Index requirements: Some price-weighted indexes favor lower-priced stocks
- Options trading: Lower prices make options more accessible to retail traders
The Stock Split Timeline
Understanding the key dates is crucial for trading splits:
- Announcement date: When the company publicly announces the split
- Record date: You must own shares by this date to receive the additional shares
- Ex-date (split date): The day the split takes effect and shares trade at the new price
Trading Strategies Around Stock Splits
Strategy 1: Buy on Announcement
The announcement of a stock split often causes an immediate price jump. Many traders buy shares right after the announcement, betting that positive momentum will continue.
Example
Tesla announced a 5-for-1 split on August 11, 2020, when shares were trading around $1,374. By the time the split happened on August 31, shares had risen to over $2,200 (pre-split), a gain of more than 60% in just three weeks.
Strategy 2: Run-Up Before Split Date
Stocks often continue to rise in the weeks between the announcement and the actual split date. This "split run-up" happens because of increased media attention and retail investor interest.
Example
Apple announced a 4-for-1 split on July 30, 2020. The stock traded at $384 on announcement day. By the August 28 split date, shares had climbed to $499, a 30% gain during the run-up period.
Strategy 3: Post-Split Momentum
Some traders wait until after the split to buy, betting that the lower price will attract new buyers. This strategy works best when the broader market is bullish and the company has strong fundamentals.
Strategy 4: Sell the News
The classic "buy the rumor, sell the news" approach. Some traders sell their positions on or just before the split date, taking profits from the run-up. This can be effective when the stock has already made significant gains.
Options Strategies for Stock Splits
Stock splits create interesting opportunities for options traders:
- Call options before announcement: If you anticipate a split, buying calls can magnify your gains
- Selling covered calls during run-up: Collect premium while participating in the upside
- Post-split options: Lower stock prices mean lower options premiums, making strategies more accessible
Important note: When a stock splits, your options contracts are adjusted automatically. The strike prices and number of contracts change proportionally so the total value remains the same.
Historical Performance of Stock Splits
Research shows mixed results for stock split performance:
- Stocks typically outperform the market in the 12 months leading up to a split announcement
- There is often a positive price reaction on the announcement day (averaging 2-4%)
- The run-up period between announcement and split date often shows continued gains
- Post-split performance is less predictable and depends on market conditions
Common Mistakes to Avoid
- Thinking splits create value: A split does not make the company more valuable. It is purely cosmetic.
- Chasing after big run-ups: If a stock has already gained 50% after a split announcement, the easy money may be gone.
- Ignoring fundamentals: A split does not fix a struggling company. Always check the underlying business.
- Overleveraging: Using too much margin or too many options can lead to devastating losses if the trade goes wrong.
- Forgetting about taxes: Short-term gains from split trades are taxed at your ordinary income rate.
How to Find Upcoming Stock Splits
Stay informed about upcoming splits by:
- Monitoring financial news sites for split announcements
- Using stock screeners that track corporate actions
- Following SEC filings for companies you are interested in
- Setting up alerts for stocks trading at all-time highs (potential split candidates)
Track Your Stock Split Trades
Pro Trader Dashboard helps you track all your trades around corporate events like stock splits. See your performance data, analyze your timing, and improve your strategy over time.
Summary
Stock splits create trading opportunities both before and after the event. The key is understanding the timeline, having a clear strategy, and managing your risk. Remember that while splits often generate excitement, they do not change the fundamental value of a company. Focus on quality companies with strong growth prospects, and use splits as potential entry points rather than the sole reason to buy.
Want to learn about the opposite scenario? Check out our guide on trading reverse stock splits or explore merger and acquisition trading strategies.