Can someone help me understand options and ex-dividend stocks?

I am trying to get a handle on exactly what happens from a calendar and money flow standpoint when stocks go ex-dividend and dividends are paid. I will create a hypothetical situation. Can someone fill in the rest? Note: I am not looking for comments on this as a strategy, I am simply trying to understand how money flows and what happens to stock and options prices because I have never been long a stock with a covered call that crossed an ex-dividend date and my virtual account doesn't pay dividends. Consequently I cannot see what actually happens.

JNJ has an ex-dividend date of 2/22/13 for a dividend of $0.61/shr. On 2/21/13 I purchase 100 shares of JNJ at $76.55/sh. At the same time I sell a 75 strike call for $1.64. (yes, I know I could get early exercised. Assume I don't.) So far I have:

2/20/13: ($7655.00) + 100 JNJ@$76.55

2/20/13 $164 -1 75CallJNJ 1Mar13 @ $1.64

Having bought the day before ex-dividend I believe I will get a $61.00 dividend payment. What happens to the stock and option price?

4 Answers

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  • 7 years ago
    Favorite Answer

    All else bing equal you expect the stock price to drop by about $0.61.

    You do expect some decrease in the price of the call option because it is an American-style call option. Given the extrinsic value (time value) of the option is only $0.09 I would not expect the decrease to be the full $0.61. If it were a put option or a European-style call option I would not expect any any change in the option price. (With a put option there would be no advantage in exercising the option early. With a European-style call you would not be allowed to exercise the option early. With an American-style call option the option holder can take advantage of the dividend by exercising the option early.)

    Your maximum potential profit occurs if the call option is exercised after the stock has gone ex-dividend. If that happens your effective sale price per share would be $75.00 + $1.64 = $76.64 per share. That is $0.09 more than you paid for the stock, so your maximum potential profit is $0.61 + $0.09 = $0.70 per share before commissions, less than 1% of your net cost to open the positions.

    If you are assigned before the stock goes ex-dividend your maximum potential profit is $0.09 per share before commissions. Unless you pay less than $3.00 per trade in commissions you would end up with a small loss. (Sorry, I could not bring myself to assume something that is a real possibility will not happen, even though you made it clear you are you asking what would happen if you were not assigned early.)

    Finally, I assume you understand that we are only discussing the impact on prices due to the dividend and that other factors could have larger impacts on prices.

    Source(s): Books, classes and discussions with market makers. In my own option trading I avoided holding option positions when the underlying stock went ex-dividend.
  • knodel
    Lv 4
    3 years ago

    Splits will decrease the cost of the inventory. So that's benificial for people who sell call and purchase places and not benificial to those who purchase calls and sell places. Dividends will less costly with the help of that quantity theoretically for a quick era. So the effect is comparable as above. For Bonus shares then kind of shares staggering will enhance that may deliver down the cost and the effect is comparable as above. the effect happens during the fact time.

  • John
    Lv 6
    7 years ago

    a) You expect the stock price to drop by the $0.61

    b) You do not expect anything to happen to the option price because of the dividend payment as the dividend payment was known and expected as part of the option price (there's a tiny caveat in this about early exercise).

    c) You finally have $2.25/share in cash, a tax bill, and have given away any upside on your stock while you keep all the downside. If JNJ drops to $52 you will really wish you didn't do this trade.

  • Raysor
    Lv 7
    7 years ago

    they go down

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