Exercised on dividend date....?

[dickey7]

I had read somewhere, and can not find it now, that being exercised on a sold call option on dividend date was determined by the pricing of the corresponding Put. I understand there are other variables, but is the statement above correct and what is the math behind it? Got exercised on a large batch the other day before ex dividend date and trying to understand why, as I wasn’t expecting it.

Thanks

 

[FSU]

That's correct. Just think of a conversion spread, a neutral spread where you are long stock, short calls and long the same strike put. If someone is long calls, its the same synthetic position is long stock and long puts. So if I am long calls, if I exercise them to obtain the dividend, I will have long stock. If I then buy the puts, I have the same thing synthetically as I did before (long calls only). So if the dividend is more then the cost of the puts and the carry costs of the long stock I will have, it is worth it to exercise.

So the math is basically carry cost of the stock to expiration and the cost of the put, if these both are less then the dividend its worth it to exercise a call before a dividend.

 

[dickey7]

So usually the exercise is the end of the day before ex dividend date. So what is the carry cost of the stock, $0...?

And I think that means, they are buying the corresponding Put, which neutralizes the most of the risk of carrying stock when they exercise the call option, and the dividend is greater than then cost of Put... and that’d be the margin basically, difference in Put and dividend. Any fluctuations from there offset between stock and put intrinsic value. ?

 

[qwerty11]

Carrying cost of the stock is based on the interest........

(I don't mention possible lending profits because most dividend paying stocks have very low lending rates (also compared to the cash interest))

 

[FSU]

So usually the exercise is the end of the day before ex dividend date. So what is the carry cost of the stock, $0...?

Carry cost refers to the date of the expiration of the options. So for example if you were long an June 80 call in a $100 stock and exercise it today for the dividend, then buy the put, you would carry that stock until June expiration. So before you were holding a $20 ($2,000) call, now you are holding $10,000 worth of stock. So you would calculate the extra interest cost to hold the stock until the June expiration.

 

[dickey7]

I don’t think it’s common for options to be exercised that are a ways out from expiration. But I think I understand to keep an eye on the put price now, or difference in put vs strike price less dividend amount.

 

[dickey7]

Alright. Trying to make sure I understand this concept. See image attached, assume this is the closing data for today. MSFT is going Ex tomorrow for 0.46 per share. Let’s assume holding the 124 strike as a covered call. How do I tell if I’m going to be excercsed? The carry would be negligible here I do believe....

 

[FSU]

How do I tell if I’m going to be excercsed?

Read post #2

The May 124 calls should not be exercised as of the current prices (which doesn't mean someone wont do it anyway.)

First they are trading with .30 of premium, which would suggest its not a good do, but imagine you are holding these. If you exercised, you would then have long stock, and would get the .46 dividend. You would then have to buy the May 124 put to have the equivalent position you had before (just long the calls) The puts are trading .75 as I type this, so you would lose .29 plus a small amount of cost of carry and commissions.

 

[dickey7]

Thanks FSU, very helpful and I appreciate that. The time premium is a big hurdle they have to get over first, and the put cost to keep or protect same position. I got it now boys, watch out! With weeklies it’ll depend a lot on what day of the week (I.e. - how much premium is left on them).
Thanks again, sir.