Inputting Dividend Data into the
Pricing Model
Often dividend payments are regular and predictable. With many
companies, the dividend remains constant quarter after quarter. Some
corporations have a track record of incrementally increasing their dividends
every year. Some companies pay dividends in a very irregular fashion, by
paying special dividends that are often announced as a surprise to investors.
In a truly capitalist society, there are no restrictions and no rules on when,
whether, or how corporations pay dividends to their shareholders.
Unpredictability of dividends, though, can create problems in options
valuation.
When a company has a constant, reasonably predictable dividend, there is
not a lot of guesswork. Take Exelon Corp. (EXC). From November 2008 to
the time of this writing, Exelon has paid a regular quarterly dividend of
$0.525. During that period, a trader has needed simply to enter 0.525 into
the pricing calculator for all expected future dividends to generate the
theoretical value. Based on recent past performance, the trader could feel
confident that the computed analytics were reasonably accurate. If the
trader believed the company would continue its current dividend policy,
there would be little options-related dividend risk—unless things changed.
When there is uncertainty about when future dividends will be paid in
what amounts, the level of dividend-related risk begins to increase. The
more uncertainty, the more risk. Let’s examine an interesting case study:
General Electric (GE).
For a long time, GE was a company that has had a history of increasing
its dividends at fairly regular intervals. In fact, there was more than a 30-
year stretch in which GE increased its dividend every year. During most of
the first decade of the 2000s, increases in GE’s dividend payments were
around one to six cents and tended to occur toward the end of December,
after December expiration. The dividends were paid four times per year but
not exactly quarterly. For several years, the ex-dates were in February, June,
September, and December. Option traders trading GE options had a pretty