The traders must do the math before each ex-dividend date in option
classes they trade. The traders have to determine if the benefit from
exercising—or the price at which the synthetic put is essentially being sold
—is more or less than the price at which they can sell the put. The math
used here is adopted from put-call parity:
This shows the case where the traders can effectively synthetically sell the
put (by exercising) for more than the current put value. Tactically, it’s
appropriate to use the bid price for the put in this calculation since that is
the price at which the put can be sold.
In this case, the traders would be inclined to not exercise. It would be
theoretically more beneficial to sell the put if the trader is so inclined.
Here, the traders, from a valuation perspective, are indifferent as to whether
or not to exercise. The question then is simply: do they want to sell the put
at this price?
Professionals and big retail traders who are long (ITM) calls—whether as
part of a reversal, part of another type of spread, or because they are long
the calls outright—must do this math the day before each ex-dividend date
to maximize profits and minimize losses. Not exercising, or forgetting to
exercise, can be a costly mistake. Traders who are short ITM dividend-
paying calls, however, can reap the benefits of those sleeping on the job. It
works both ways.
Traders who are long stock and short calls at parity before the ex-date
may stand to benefit if some of the calls do not get assigned. Any shares of
long stock remaining on the ex-date will result in the traders receiving
dividends. If the dividends that will be received are greater in value than the
interest that will subsequently be paid on the long stock, the traders may
stand reap an arbitrage profit because of long call holders’ forgetting to
exercise.