Dividend Size
It’s not just the date but also the size of the dividend that matters. When
companies change the amount of the dividend, options prices follow in step.
In 2004, when Microsoft (MSFT) paid a special dividend of $3 per share,
there were unexpected winners and losers in the Microsoft options. Traders
who were long calls or short puts were adversely affected by this change in
dividend policy. Traders with short calls or long puts benefited. With long-
term options, even less anomalous changes in the size of the dividend can
have dramatic effects on options values.
Let’s study an example of how an unexpected rise in the quarterly
dividend of a stock affects a long call position. Extremely Yellow Zebra
Corp. (XYZ) has been paying a quarterly dividend of $0.10. After a steady
rise in stock price to $61 per share, XYZ declares a dividend payment of
$0.50. It is expected that the company will continue to pay $0.50 per
quarter. A trader, James, owns the 528-day 60-strike calls, which were
trading at 9.80 before the dividend increase was announced.
Exhibit 8.2 compares the values of the long-term call using a $0.10
quarterly dividend and using a $0.50 quarterly dividend.
EXHIBIT 8.2 Effect of change in quarterly dividend on call value.
This $0.40 dividend increase will have a big effect on James’s calls. With
528 days until expiration, there will be six dividends involved. Because