Options Forum: The One-Time Dividend

Steve:

If an investor was long Microsoft calls, what would a huge, one-time cash dividend do to the call option? Thank you.

-- G.M.

A recent spate of special dividends, or one-time payments, issued by companies such as Metro-Goldwyn-Mayer(MGM Quote) and Blockbuster (BBI Quote) has prompted similar questions. Typically, the options are adjusted by decreasing the strike price by the amount of the cash dividend. The multiplier remains at 100 in terms of both shares controlled (one call contract equals 100 shares), and in price (a $1 option equates to a $100 value).

You can look at this story regarding MGM's recent $8-a-share special dividend for a recent example of what happens. For further information on other individual issues, go to this page on the Chicago Board of Options Exchange Web site and simply type in the company's name or ticker symbol.

Note that the adjustments made for a special payout are different than what typically occurs in a stock split. In splits, the option's aggregate exercise value always remains the same. So, if XYZ Corp. is trading at $60 and announces a 2-for-1 split, the owner of one 60 strike (or put) -- regardless of the month -- gets two 30 strike calls (or puts). In the case of a fractional split, such as a 3-for-2, the 60 strike becomes a 40 strike on 150 shares, but each strike still represents a $6,000 aggregate value of the underlying shares.

Steve:

I am getting hung up on the difference between two iShares vehicles, IWN vs. IWM. I have looked around but have not found a good explanation. Do you have a source or could you tell me? Thanks.

-- B.B.

The IWM is an exchange-traded fund that tracks the Russell 2000 index, while the IWN is based on the Russell 2000 Value Index. (Although the annual reconstitution of the Russell indices takes place June 25, the official list won't be released until July 6, so these links do not yet reflect the changes.)

The Value Index, according to Russell, "seeks investment results that correspond to the performance of publicly traded U.S. small-cap value stocks with the lowest price-to-book ratios and forecast growth within the Russell 2000 Index." Those criteria and objectives are evident when comparing some of the simple ratios: The Value Index sports a P/E of 17.15, a price-to-book of 2.84 and a beta of 1.23, while the overall Russell 2000 has a P/E of 20.59, a price-to-book of 3.78 and a beta of 1.35.