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HezBallah
Registered: Jan 2008
Posts: 136 |
09-26-12 06:17 PM
Assume a customer holds 1 ABC Oct 60 Put contract. The market price of ABC is currently $60. On an ex-date with a dividend of $4, the new market price is $56. The contract is still a ABC Oct 60 put correct? The strike and multiplier do not change? So what happens to the premium? Does it just jump up around $4 (there's still time value so it's probably around $4, not exactly)? Why is this? What's the logic?
Sorry I'm studying for my series 56 and my book doesn't have a clearer explanation.
I know for stock dividends, the contract stays the same. But why does it stay the same for cash dividends?
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newwurldmn
Registered: Apr 2011
Posts: 2617 |
09-26-12 06:19 PM
Quote from HezBallah:
Assume a customer holds 1 ABC Oct 60 Put contract. The market price of ABC is currently $60. On an ex-date with a dividend of $4, the new market price is $56. The contract is still a ABC Oct 60 put correct? The strike and multiplier do not change? So what happens to the premium? Does it just jump up around $4 (there's still time value so it's probably around $4, not exactly)? Why is this? What's the logic?
Sorry I'm studying for my series 56 and my book doesn't have a clearer explanation.
I know for stock dividends, the contract stays the same. But why does it stay the same for cash dividends?
The premium before hand would be well over $4. So after the dividend the premium would not change. The market would be treating the option as though it were $4 in the money.
This is observable in names like NLY where the dividend is large compared to the stock price.
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nazzdack
Registered: Jul 2004
Posts: 8408 |
09-26-12 06:47 PM
Quote from HezBallah:
----Put contract.
----ex-date....
----what happens to the premium?
----Why is this?
----What's the logic?
1) The dividend "builds up" in the put-premium making the premium appear "large" compared to a put-option on a non-dividend paying stock. 
2) There is no "free money" to be earned by buying the put-option immediately before ex-dividend day as a lot of rookies think they can do that by short-selling the stock before ex-dividend day. 
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trader198
Registered: Mar 2010
Posts: 1217 |
09-27-12 02:45 AM
theoretically primum already factored in the options. so it does not affect the premium after the didveed.
but in reality, I studied the case last friday SPY/QQQ divedend day.
ES friday morning gapped up, SPY gapped down, but its call does not move or a slightly lower than it should be. its put dropped more than it should. so eitherway, there are loss. of course you can think it as time decay.
better avoid the divdend day. it created confusion.
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sle
Registered: Apr 2003
Posts: 1609 |
09-27-12 05:05 AM
(a) Options are priced off the forward price, not spot, so both dividend and borrow rates are accounted for in the option price. It is a common mistake to price an option using the spot price and an average dividend yield.
(b) There is nothing mysterious about handling the dividends. If you own a deep ITM american call, you should early exercise it. For European option it does not matter.
(c) Dividends are frequently mis-priced. The option market just uses the best guess and creating div-arb trades (long-dated combo vs the stock) requires a lot of financing and balance sheet cost.
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