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# Exercise of call option on a dividend paying stock

Discussion in 'Options' started by wooldog, Jul 29, 2011.

1. ### wooldog

If I'm short an in the money call, and the extrinsic value of the call is greater than the dividend, then I am safe from being exercised. Is that correct?

No. Look at the Put. If the dividend - interest carry cost, is greater than the value of the put, most traders would exercise the call. There is still normally a small open interest even with that condition.

3. ### wooldog

Hmmm, the put? Can you walk me through why that's the case?

Jsantos09 likes this.
4. ### FSU

Not necessarily. The best way to tell if a call should be exercised for a dividend, is by looking at the corresponding put and the cost of carry of the stock. So if the put of the same strike as your call is going for .20 and the dividend is a .80, it would be a good exercise as long as the cost of carry of holding the stock to expiration is less than .60.

Because a long call, is hedged with short stock. So an deep ITM call near the x-div date on a security with a large dividend, would have 100 delta. Now, if I'm hedged on long 50 calls, I'm short 5000 common. That is a synthetic put. If the dividend is coming up and I want to maintain my position, I can exercise my call and replace with the put. But only if the put is cheaper than the cost of the dividend - interest.

If I had no stock position, and I was just long 50 deep ITM calls, and want to keep that position, if the math works, I can exercise the call, now I'm long the common, and go out and buy 50 Puts. My new position would be +5000 common + 50 puts, or a synthetic call.

If that's does not help, PM me and I'll explain on the phone.

Bob

6. ### KPS21

Check the price of the put option on the same strike in relation to the dividend.

Owning the call is like owning both the stock and the put, right?. When the call holder exercises, he will be left with ONLY the stock.

So by exercising, he has essentially forfeited his put in exchange for the dividend.

A rational person will not do this unless the dividend is worth more than the put option he is essentially giving up, barring some other minor complications.

7. ### wooldog

FSU, rmorse, and KPS thanks.

I think I get it, but I'm going to have to roll it over in my brain and think about it, tinker with some examples etc. I appreciate the responses.

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