[Xcelerate]

I don’t really understand stock splits. Is the only point to allow people to buy shares who could previously not buy because one share was too expensive? If so, why not just introduce fractional shares into the stock market with some fixed point number of decimal places? Or just keep track of ownership fraction (e.g. 0.0043% of the company)?

[mehrdada]

One thing it can impact is derivatives trading. A standard option contract controls 100 shares, which can be quite a large amount of $ if each individual share is priced highly (likewise affects the effective granularity of the common option strike prices in the market)

Update: For something like TSLA which may have some psychological "Bitcoin-like" speculation going on among retail investors, I suppose the big number could reduce the desire to buy since "it can't go much higher" in some people's head, I guess.

[oh_sigh]

Is there any reason beyond legacy that option contracts come in 100 share bundles?

[mehrdada]

You have to standardize on some common granularity for strikes/expiration dates so that each symbol has sufficient volume so that the market would not get too sparse. The theory does not require it, but when you are building an exchange, I suppose that'd be of a practical concern to you. You want interchangeability in derivative contracts and don't want each individual contract to be a snowflake.

There are "mini" options that control 10 shares, for example, but they usually have higher bid-ask spread reflecting the higher cost of pricing accurately/transaction fee/lower liquidity.

[km3r]

Wouldn't make more sense to make contracts that control 1 share so that sparseness is minimized?

[betterunix2]

You would have contracts trading for less than a dollar, which would make the system a lot less efficient (higher transaction fees etc.), not to mention raising the computational cost of matching contracts when they are exercised (there would be far more contracts to deal with).

[betterunix2]

100 shares is considered a "lot" and is a standard size. True, an investor can own fewer than 100 shares, but every so often a company will make an "odd lot offer" forcing investors to either sell their shares or buy enough to hold at least 100.

Another issue is that out of the money contracts for a single share would frequently trade for pennies, which would greatly increase transaction costs and make the market less efficient. So you would have to standardize on some amount that is large enough to avoid such inefficiency, and 100 is a convenient number for mental arithmetic and reduces confusion. In theory you could have standardized on a larger number like 1000, which is equally convenient, but that would have priced out retail investors who may not own 1000 shares of a company whose share price is in the double or triple digits (which is common) and reduced the liquidity of the options market (which is already not very liquid).

[arthurcolle]

Different derivatives have different lot sizes iirc. Options contracts for listed equities have a lot size of 100. Once options markets became more standardized in 1973 with CBOE introducing call options, the default lot size became 100.

From /u/ins2be on reddit:

"That's what the OCC sets it at in their bylaws.

Unit of Trading

(5) The term “unit of trading” in respect of any series of options or futures means the number of units of the underlying interest which have been designated by the Corporation as the minimum number to be the subject of a single option contract or single future in such series. In the absence of any such designation for a series of options or futures in which the underlying security is a common stock the unit of trading shall be 100 shares."

[rich_sasha]

There are weird incentives for this.

In US the tick size for any stock is always $0.01. So a stock with a price of say $1 has a minimum bid ask spread of 1%, which is a lot.

On the contrary, if one share is too expensive, it limits liquidity in a stock. This is usually bad, though Berkshire Hathaway voting shares are deliberately kept expensive to stave off speculators.

This then get meta-player. A split suggests the company expects a price increase, and vice versa (reverse splits area thing too).

[esrauch]

It seems very strange; can a share not be worth less than 1 cent, or can it for ask but not bid?

[cynix]

It can be "worth" less than 1 cent. That simply means if you put in an offer at 1 cent, nobody will buy it, because they think it's worth less.

[esrauch]

I meant if the bid-ask spread must be minimum 1 cent, then is it true that bid can't be lower than 1 cent as long as ask is semipositive?

[betterunix2]

Liquidity rules are the main reason. Even Berkshire Hathaway had to give in and create the Class B shares in response to pressure from institutional investors constrained by liquidity requirements. Brokerages are also less willing to allow margin trading on equities with low liquidity because of the risk that a customer will be unable to sell their assets to cover margin calls.

As for fractional shares, keep in mind that these are a creation of brokerages, they are not universally available, and they create complications with shareholder rights (e.g. voting).

[JoshTko]

It's also generally considered a positive signal, that management is confident that nothing is going materially, negatively impact the stock price moving forward.

[abfan1127]

there was a time when you couldn't buy fractions of a share. Then it made sense to keep shares "lower" for smaller increments of share purchases. But now, most exchanges that I'm aware of allow fractional share purchases. Fractional share ownership may affect voting rights. I too would like to know "why" Tesla would opt for this... seems like they have more important things to do.

[arthurcolle]

The exchanges don't allow it, the brokers do.

[templaedhel]

Matt Levine (as usual) has some good explanations for the value (or lack thereof) of stock splits, as well as some historical context, as seen via the lens of the recent Apple split: https://www.bloomberg.com/opinion/articles/2020-07-31/apple-... (Bloomberg has a pretty aggressive paywall, but usually a new incognito tab will bypass it).

"A company should be a thing, and people should be able to own a portion of its equity, and the portion that each person owned would be expressed as an arbitrarily precise percentage of the total...The “stock price” would be what we now call the “market cap”: The market would place a value of $X on the company as a whole, and if I wanted to buy another 0.01429% I would pay 0.01429% of $X....

The traditional, 19th-century answer to how many shares a company should have was that stocks should have a normal price, they should cost like $40 to $100...This was so standard that, when Charles Dow created a stock index in 1884, he just averaged the dollar stock prices of a bunch of stocks...because the stocks had normal prices.

There is an argument that high-priced stocks reduce liquidity because traders have less incentive to post quotes. It is good for a stock to trade at a bid/ask spread of a couple of “ticks,” the minimum price increment for trading. If a stock is worth $50 and trades at a bid/ask spread of $49.99/$50.01, a trader who posts a bid to buy at $49.99 will be able to buy from anyone who wants to sell immediately. If it’s worth $500 and trades at $499.90/$500.10, a trader who posts a bid to buy at $499.90 might lose out to a trader who bids $499.91. You can’t reliably earn a “normal” spread by trading the stock, so your incentive to provide liquidity is lower. Nasdaq published a paper arguing this point

At the time of Apple’s last split, in 2014, one popular explanation was that Apple was trying to get into the Dow Jones Industrial Average, which is still price-weighted and so still has an old-fashioned fondness for normal-priced stocks, but that worked and now it’s in the Dow so that’s no reason to split again"

[quickthrowman]

To entice retail investors to dump money in, brokered by Robinhood, one share at a time (in TSLAs case)

I’m on the fence about TSLA, their value is based on their perceived lead on autonomous driving, which is questionable. Their accounting practices are a bit shady as well. I’m not looking forward to it’s inclusion to the S&P 500.

[StickyRibbs]

Stock splits can also be used for companies with values too low (A reverse split) . These companies split to increase the value of stocks in order to prevent delisting from exchanges.

[abfan1127]

wouldn't a split lower the value of the share price, making it closer to a "penny stock"?

[chrishas35]

It's commonly called a reverse split.

[jedberg]

That's a reverse split. Take the price ie from 10 cents to $1 by doing a 1 for 10 reverse split.

[trianglem]

I think I prefer stock splits over dealing with fractional shares.

[bob1029]

Fractional shares are already a thing on many brokerage platforms.

[0xRCA]

Yes, and also finer grained control in general even for larger portfolios. Almost like increasing the resolution.

[dpc_pw]

Also makes the perception of the stock being cheaper. I can't tell you how many times I heard someone say company X stock is cheaper than company Y becausetthey compare nominal price.