Steven, as more companies begin paying dividends and increasing the payout, could you explain how this affects option holders, especially regarding exercise and ex-dividend dates? Thanks for all your stuff.
-- Rick Gottlieb
Rick is right on target with his timely question regarding how dividends factor into options pricing and how this may affect strategy and position decisions.
By definition, companies pay dividends to investors who are shareholders of record on a specified date. An equally important date to be aware of is the ex-dividend date. An investor needs to be in possession of the stock before the ex-dividend date to qualify for the periodic dividend.
The dividend may not be actually paid for two to four weeks after the ex-date. But you don't have to own the shares after the ex-date to receive the dividend. Most stock trades take three business days to be delivered -- there are some exceptions, so double-check specific situations -- and most transactions adhere to the T+3 rule regarding settlement. This typically means a stock will "go ex-dividend" three days prior to the date of record. Transactions made after the ex-dividend date, but before the date of record, would result in the seller receiving that period's dividend, not the buyer.
It's important to be aware of the different dates -- ex-dividend, holder of record and actual payment date -- and their implications regarding dividend payments. Even if you confuse them, the stock and option prices should reflect the impending event. As the stock gets closer to the next ex-dividend date, the price may gradually rise in anticipation of the dividend. Conversely, once the stock goes "ex," you might see the share price decline in an amount commensurate with the upcoming distribution.
You Want How Much When?
If you're long call options on a stock paying-dividend, you must exercise the option the day before the ex-date if you want to collect the dividend. Remember: the dividend payment is the responsibility -- and sometimes an unanticipated liability -- of people that are short stock or in-the-money call options. If you've assigned your short calls and don't buy underlying shares to flatten your position before the ex-date, you'll be required to pay the dividend to the shareholder of record.
If you've been working a covered call program and the call is in the money with the stock's ex-date is approaching, assume the option will be assigned and the long stock called away from you.
To avoid this, you might want to consider rolling the call -- even temporarily -- to a higher strike price that is out of the money until the ex-date passes. While this position adjustment will reduce the downside protection, it also allows you to maintain the long stock position and collect the dividend.
If you're long a vertical call spread in which the lower strike is in the money, you may choose to exercise that option -- go long the stock while maintaining the short call in the higher strike. This essentially turns the spread position into a covered call to collect the dividend income.
Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to