Dividends And Options Demystified

Stock dividends have an important impact on how options for that stock are priced. All else being equal, stocks generally fall by the amount of the dividend payment on the ex-dividend date. This impacts the pricing of options. 

Calls are less expensive leading up to the ex-dividend date because of the expected fall in the price of the underlying stock. At the same time, the price of Puts are more expensive leading up to the ex-dividend date due to the same expected drop.  The mathematics of the pricing of options is important for investors to understand in order to make informed trading decisions.

There are two important dates investors need to know for the payment of dividends. The first is the record date. This date is set by the company when a dividend is declared. An investor must own the stock by that date to be eligible for the dividend.  But, since it takes time for the exchange to complete paperwork to settle the transaction, an investor must purchase the stock THREE BUSINESS DAYS ahead of the record date.  This is known as T+3. 


The investor must own the stock BEFORE the ex-dividend date. The ex-dividend date is essentially the cut-off date for the payment of the dividend. Any shares that trade on the ex-dividend date are not eligible to receive the dividend.

The ex-dividend date is therefore the crucial date. If a company is making a decent-sized dividend payment, investors are willing to pay a premium for the stock in the days leading up to the ex-dividend date to receive the dividend. On the ex-dividend date, the exchanges automatically reduce the price of the stock by the amount of the dividend. For example, assume the stock for ABC, Inc. is trading at $50 the day prior to the ex-dividend date and is paying a $1 dividend. The exchange automatically adjusts the price of the stock to $49 since the dividend is not included in the price. This is known as the stock going ex-dividend. Some stock quote systems and newspapers list an “x” next to the stock quote to signify it is going ex-dividend.




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