Beware: Call writers must pay dividend

Reply to qazmax:

Regarding experience: it seem that a classical way for experience to help you is when you experienced this first hand.

I don't know why the Options Clearing Corporation insists on giving someone credit for owning the stock the second he exercises his options to have to create a situation that the one who wrote the options cannot just deliver the stock the next day (when he finds out about it) to fill his duties, and rather must act as if he is the company paying the dividend. Let the one who bought the options exercise them one day earlier and then everyone will have notice--then no harm to anyone.

Because the rule is absurd, the brokers' duty increases to inform the clients this information about the assignment procedure. Why is it not in the risk disclosure?
 
Quote from def:

option trader,

this is standard options theory and the probability of getting assigned is quantifiable (ie. via simple math you can determine whether or not it is worth exercising an option before the ex-date).

The basics:

If a stock goes ex-div tomorrow, they are exercising the option on t-1 (i.e. today) because - all things being the same - on the open tomorrow the stock will drop by the amount of the dividend. Thus upon the record date of the dividend, they will be long the stock and the person shorting the option who got assigned will thus be short the stock.

Now the good news, assuming you shorted at a fair price, the amount you pay in dividends was priced into value of the option. As a result the act of getting assigned didn't cost you money as you already "received" the dividend.

as for liffe, I'd be surprised it is handled any differently. i.e. if you are short the stock on the ex-date you'll have to pay the dividend.
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Absolutely correct.
 
Response to cnms2

See my response earlier to def for 2 important corrections to def's message regarding t-1 and regarding that it is only incorporated partially into the option price; best proof is, get a list of dividend paying stocks and see how much you can get for selling in-the-money calls. You will be disappointed.
 
Quote from Option Trader:

Response to cnms2

See my response earlier to def for 2 important corrections to def's message regarding t-1 and regarding that it is only incorporated partially into the option price; best proof is, get a list of dividend paying stocks and see how much you can get for selling in-the-money calls. You will be disappointed.
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option trader,
trust me, if the probability of the option being exercised before the ex-date is 100% the dividend is priced into the option.

you make a couple of inaccurate statements in the post prior to this. if you exercise a call, you do not immediately own the stock. You exercise the day BEFORE the ex-date so you become a shareholder of record on the record date (ie. the settlement date of the stock). This is the same a purchasing a stock. If you purchase a stock the day before the ex-date, you'll receive the dividend. If you purchase on the ex-date you don't. The converse is true as well. If you short the day before ex, you need to pay the dividend.


Take a look at this link for a better explanation.

http://www.investopedia.com/articles/optioninvestor/03/121003.asp
 
Quote from novel20:

It is already priced in. Amazing how blind leading blind. def is correct though.
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What's actually amazing is how many actually believe that everything is efficient "all" the time (Def: you know better).

Ask Mr. SHOO how inefficient the "dividend play" can be....

thanks for the dough Mr. SHOO..........Hope to see you soon
 
Quote from novel20:

It is already priced in. Amazing how blind leading blind. def is correct though.
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How is it already "priced in"? Dividends make calls cheaper and the original premise was a short call. So, you received less credit for your short Call because of the dividend.

If the call is exercised on the day before ex-dividend the next day you will be short the stock and have to pay the dividend.

What am I missing?
 
Response to def,

I know of a case that a person got an extra $.10 estimate for the premium and had to pay $.40 for the dividend. It was part of a spread strategy; the numbers looked good on the surface, but the dividend hit a month later. The loss was over $50k.

Perhaps, def, when you say it is factored in, you are counting the premium which anyway would have been offered. That cannot count, as the long option the person buys also has a premium he is paying and which he is risking.

One other point, it is wrong to equate buying a stock the day before ex-dividend, where the seller knows he is short the stock, versus if an option is exercised and the buyer will not find out till the next day and opened the position believing handling an assignment the next day is as simple as it sounds.

Brokers should make a better disclosure to protect their clients. This is especially true because some clients do market scans looking for the best option plays and can end up losing big.
 
Quote from Don87109:

How is it already "priced in"? Dividends make calls cheaper and the original premise was a short call. So, you received less credit for your short Call because of the dividend.

If the call is exercised on the day before ex-dividend the next day you will be short the stock and have to pay the dividend.

What am I missing?
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Dividends make calls cheaper only if out-of-the-money. If in-the-money they should be more expensive because of the dividend, but that is true only for the ask price from my experience. Since you sell at bid you might get only a slight increase.
 
Quote from Option Trader:

Dividends make calls cheaper only if out-of-the-money. If in-the-money they should be more expensive because of the dividend, ....
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Do you mean the difference between an American and an otherwise identical European call?
 
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