Options Dividend Risk

Options Dividend Risk

While option investors don’t receive dividends if they don’t own the stock, there may be times when trades are exposed to options dividend risk for in-the-money short calls.

Let’s see why it’s a risk and what to do in that situation.

Suppose an options investor placed a diagonal call spread in Abbvie (ABBV).

Date: Jan 11, 2020

Price: $109.02

Buy one ABBV Feb 19 $100 call @ $9.25
Sell one ABBV Jan 29 $105 call @ $4.40

Debit: $4.85

(We will see later why this diagonal trade was constructed incorrectly which caused the early assignment problem.)

Nasdaq.com shows that ABBV pays a $1.30 dividend on February 16 (payment date) to all stock owners who are on record January 15 (record date).

In order to be “on record”, the investor needs to purchase the stock prior to the ex-dividend date of January 14 (because it takes time for the purchase to settle into the books).

That means the investor needs to purchase the stock on January 13th at the latest.

Note that the diagonal spread had sold a call option which gives the buyer of that call the right to acquire 100 shares of ABBV stock at $105 anytime through expiration January 29.

This is known as exercise right.

One hour before market close on January 13, ABBV was trading at $112.88.

The call option with a strike $105 is in-the-money.

More specifically, it is in-the-money by $7.88.

At the same time, the call option is valued at $7.90.

That means $7.88 of that option’s price is intrinsic value.

The remaining $0.02 is extrinsic value.

Whenever the holder of an option exercises that option early (before expiration), the holder gives up the extrinsic value of the option when converting the option into stock.

In this case, $0.02 per share is not much to give up, especially if converting it into stock means that he or she will get the $1.30 per share dividend.

Hence the call option is in high risk of being exercised.

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Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are ...

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