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