Add training workflow, datasets, and runbook
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Chapter I: Definitions 15
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for a 6-month call - because the underlying stock's price will be reduced by the ex
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dividend reduction, and the call holder does not receive the cash dividends.
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This particular call buyer calculated the value of the XYZ July 25 call in terms
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of what it was worth with the stock discounted to 24 - not at 25. He knew for certain
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that the stock was going to lose 1 point of value over the next 6 months, provided the
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dividend rate of XYZ stock did not change. In actual practice, option buyers tend to
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discount the upcoming dividends of the stock when they bid for the calls. However,
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not all dividends are discounted fully; usually the nearest dividend is discounted
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more heavily than are dividends to be paid at a later date. The less-volatile stocks with
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the higher dividend payout rates have lower call prices than volatile stocks with low
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payouts. In fact, in certain cases, an impending large dividend payment can substan
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tially increase the probability of an exercise of the call in advance of expiration. (This
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phenomenon is discussed more fully in the following section.) In any case, to one
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degree or another, dividends exert an important influence on the price of some calls.
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OTHER INFLUENCES
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These six factors, major and minor, are only the quantifiable influences on the price
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of an option. In practice, nonquantitative market dynamics - investor sentiment -
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can play various roles as well. In a bullish market, call premiums often expand
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because of increased demand. In bearish markets, call premiums may shrink due to
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increased supply or diminished demand. These influences, however, are normally
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short-lived and generally come into play only in dynamic market periods when emo
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tions are running high.
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EXERCISE AND ASSIGNMENT: THE MECHANICS
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The holder of an option can exercise his right at any time during the life of an option:
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Call option holders exercise to buy stock, while put option holders exercise to sell
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stock. In the event that an option is exercised, the writer of an option with the same
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terms is assigned an obligation to fulfill the terms of the option contract.
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EXERCISING THE OPTION
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The actual mechanics of exercise and assignment are fairly simple, due to the role of
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the Options Clearing Corporation (OCC). As the issuer of all listed option contracts,
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it controls all listed option exercises and assignments. Its activities are best explained
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by an example.
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