Options 101: Options Dividend Risk And How To Avoid It

Dividends Meet Options

If you’ve made an option trade, you’ve probably seen the disclaimer warning of potential dividend risk. Most probably gloss over that information and never consider how their option trades could be impacted. However, we got flooded with emails last week asking questions about this type of risk, which was a great to see. In response to the quest for information on this subject, I took one of my sessions last week to outline the risks and some rules of thumb. Now I’m bringing this information to the blog!

Dividend dates

Before you can really have a discussion of dividend risk in options, you need to understand the relevant dates. A company will frequently declare a dividend following their earnings report. This declaration includes a the amount along with the record date and the pay date.

The record date is when the company will record all of their shareholders of record. That makes sense that they’re not doling out cash to just anybody, but what does it take to become a shareholder of record?

In order to understand this, you need to understand the process of being officially recognized as a shareholder. This is usually described as T+2 or trade plus two days. For virtually all non-OTC stocks it takes two days following the trade date for you to be officially recognized as the shareholder of record.

Understanding T+2 allows you to arrive at the ex-dividend date. The ex-dividend date is the date in which the stock is purchased, you won’t be recognized as shareholder of record on the record date. This is the date the stock will drop by approximately the amount of the dividend. For example, if the dividend is $1, the stock will fall by approximately $1 on the ex-dividend date. That means that you would need to purchase the stock the day before the ex-dividend date in order to get recognized and paid. The image below breaks this down.

Dividend Risk

Now that you know the dates of interest, let’s talk about how it impacts the options. Here are a few effects to consider:

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