28 lines
1.9 KiB
Plaintext
28 lines
1.9 KiB
Plaintext
Dividend Plays
|
||
The day before an ex-dividend date in a stock, option volume can be
|
||
unusually high. Tens of thousands of contracts sometimes trade in names
|
||
that usually have average daily volumes of only a couple thousand. This
|
||
spike in volume often has nothing to do with the market’s opinion on
|
||
direction after the dividend. The heavy trading has to do with the
|
||
revaluation of the relationship of exercisable options to the underlying
|
||
expected to occur on the ex-dividend date.
|
||
Traders that are long ITM calls and short ITM calls at another strike just
|
||
before an ex-dividend date have a potential liability and a potential benefit.
|
||
The potential liability is that they can forget to exercise. This is a liability
|
||
over which the traders have complete control. The potential benefit is that
|
||
some of the short calls may not get assigned. If traders on the other side of
|
||
the short calls (the longs) forget to exercise, the traders that are short the
|
||
call make out by not having to pay the dividend on short stock.
|
||
Professionals and big retail traders who have very low transaction costs
|
||
will sometimes trade ITM call spreads during the afternoon before an ex-
|
||
dividend date. This consists of buying one call and selling another call with
|
||
a different strike price. Both calls in the dividend-play strategy are ITM and
|
||
have corresponding puts with little or no value (to be sure, the put value is
|
||
less than the dividend minus the interest). The traders trade the spreads,
|
||
fairly indifferent as to whether they buy or sell the spreads, in hope of
|
||
skating—or not getting assigned—on some of their short calls. The more
|
||
they don’t get assigned the better.
|
||
This usually occurs in options that have high open interest, meaning there
|
||
are a lot of outstanding contracts already. The more contracts in existence,
|
||
the better the possibility of someone forgetting to exercise. The greatest
|
||
volume also tends to occur in the front month. |