Sell call options before a dividend announcement?
February 29, 2012 9:21 AM   Subscribe

Newbie options investor question related to dividends.

I own in-the-money Jan 2013 call options on a company that is expected to announce a dividend at some point this year. The little research I've done on this suggests that I should sell the options before the dividend, implying the result of the dividend will be likely to deflate the price of the options. Can more experienced investors make a recommendation here? I should note, these are the first options I have ever owned so I'm in new territory.
posted by quadog to Work & Money (4 answers total)
Call options give the holder the right to acquire stock at a strike price. People will want to exercise that option prior to be dividend payment in order to acquire the underlying shares and collect those dividends.
posted by dfriedman at 9:56 AM on February 29, 2012 [1 favorite]

The current option price uses the expected dividend as an input into the model. If a new (unexpected) dividend is announced, the real value of the call will drop accordingly. If this is just a normal dividend, or even the normal growth of divvy stream, the option is probably already incorporating it into its price and it does not matter when you sell it. common pricing models if you really want to geek out.
posted by H. Roark at 10:30 AM on February 29, 2012 [1 favorite]

It depends on what you hope(d) to accomplish with these options. Is this a hedging transaction? Are you speculating with hopes of big upside? Do you have some non-consensus view on the size or timing of the dividend?

Sometimes an in-the-money option will be exercised in anticipation of a dividend because the implied time value of the option is less than the dividend being distributed.

For example, say your Jan 13 options have a strike of $5, the stock currently trades for $7, the company plans to pay a $0.50 dividend and the options currently trade for $2.25.

The current price of the options reflects $2 of intrinsic value (stock price - strike) plus $0.25 option (or time) value.

Exercising produces the following cash flows: cash out at strike price (-$5); cash in from dividend (+$0.50); and cash in at market price after selling the stock (+$7). Net cash in = $2.50

Selling produces cash flow of +$2.25. So, in this example, you'd exercise instead of sell.

But that's assuming you want out. Theoretically the value of the option will decline by the amount of the dividend (because the stock price will drop by that amount). But the ultimate cash flow still depends on where the stock price ends up at expiration. In your case, expiration is still pretty far off and a lot can happen in that time.

Say you think the stock is going to $10 by Jan 13...Why do anything in anticipation of a dividend? Maybe you can sell or exercise the option now and buy back the options at a lower price after the dividend is paid? I suppose that's possible but you're risking that the stock price jumps before you can get back in.
posted by mullacc at 10:42 AM on February 29, 2012

H. Roark hits it right on the head
posted by jjmoney at 12:08 PM on February 29, 2012

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