Regular and special dividend payments influence the price and the possibility of assignment on options. Although the impact of an ex-dividend date on an option position is usually relatively small, it is important to understand the dynamics of this process for options traders.
First, let’s clarify the language in the dividend payment process. There are several terms used, each with specific implications that can lead to some confusion for new traders.
Dividends are declared by the Board of Directors of a corporation. They announce the amount of dividend per share to be paid, when it will be paid and the Date of Record. Here is a recent sample:
Qualcomm Announces Quarterly Cash Dividend
SAN DIEGO – January 12, 2016 – Qualcomm Incorporated (NASDAQ: QCOM) today announced a quarterly cash dividend of $0.48 per common share, payable on March 23, 2016, to stockholders of record at the close of business on March 02, 2016.
The day the press release goes out announcing the upcoming dividend is the Declaration Date (sometimes called the announcement date).
The Payment Date is when the money will actually be deposited into shareholder’s account or a paper check will be issued and mailed. This is usually about a month after the Date of Record.
The Date of Record is day by which you must be ‘present’ as a stockholder and be counted among the people who will get the dividend payment. Essentially all stockholders are counted or “recorded” at the close of business on this day. This is the list of people to whom dividend payment will be sent later. The Date of Records is usually about a month after the Declaration Date.
Bizarrely, the most important date related to dividend for traders in stock and options is not mentioned in any press release about dividends! This is the ex-dividend date, which is what most technical platforms depict on the price charts, usually with the symbol D. Starting on the ex-dividend date, buyers of the stock will not be eligible for the next declared dividend payment. The ex-dividend date is 2 business days before the Date of Record.
Now let’s look at some important considerations in option trading that arise out of dividends.
When to buy stock or exercise Call options to get dividend?
To be an owner of record and be able to receive dividends, you must buy the stock or exercise your call option three days before the Date of Record.
Stock purchases in the US take three days to settle. This means if you buy a stock on Monday, it will take 3 business days to actually show up at your broker/custodian, which will be Wednesday. Therefore, if you want to buy the stock to get paid dividends, you must do it three days before the Date of Record or the day before the ex-dividend date.
If you have Long Call options that you want to convert into stock, the same rule applies. You must exercise the Call option three days before the Date of Record or the day before the ex-dividend date.
If I buy a call or put option, do I get dividends or have to pay dividends?
If you are the owner of a Call or Put, you are not going to receive dividends or have to pay dividends. Only the owner of a stock is entitled to the dividend. If you are short the stock (borrowing it from your broker), then you will be responsible for paying the dividend.
How can ex-dividend date impact my option trade?
The stock will open down by the amount of the dividend on the ex-dividend date. For example a $50 stock paying a regular quarterly dividend of $0.75 will open at $49.25 the morning of the ex-dividend date. From there supply and demand forces will take over for the rest of the session. So maybe it is a good idea to buy puts just before the ex-dividend date, watch the stock drop the next morning, and sell the puts for a profit right at the open! For obvious reasons, this is not how it works.
Option extrinsic value is “adjusted” to accommodate an upcoming ex-dividend date weeks prior to that date so that no unusual gains or losses are experienced by option traders. Call options see a decline in their extrinsic value and put options see a rise in their extrinsic value prior to the ex-dividend date.
Sometimes a large, special dividend is announced outside of the regular quarterly dividends. Maybe the company sells some assets and returns a portion or all of it to shareholders. If the dividend payment is larger than $0.125 per share, special adjustments are made to option strikes. I will write more about this process in a future blog post.
If I sell a call or put option, what is my dividend related risk?
As a writer or seller of a Call option, you are under obligation to sell stock. If your option is assigned and you DO NOT OWN the stock, your broker will sell stock short. Then the stock goes through an ex-dividend date and a dividend payment is forthcoming now. You are generally going to owe this dividend to the party that loaned you the stock.
As a writer of a put option, you are under obligation to buy the stock. If assigned, you will have to buy the stock. If you bought it before the ex-dividend date and hold it through the date of record, you will be on your way to get the next declared dividend payment.
Why did I get assigned in my covered call right before the ex-dividend date?
When your short call goes ITM (In The Money) and has a smaller extrinsic value compared to the amount of the dividend, it is at increasing risk of an early assignment. The lower the extrinsic value of the short call gets, the higher the chance of an early assignment. In short, if someone owns a long call (which you are short on), and the dividend is greater than the remaining extrinsic value of the option, it is in the long call owners best financial interest to exercise their call, forfeit the extrinsic value and receive the dividend.