Question about dividend arbitrage

S

spindr0

It has been my understanding that:

- If there is a pending dividend and the time premium of an ITM put is less than the dividend then there's an arbitrage available. IOW, buy stock, buy put, exercise after ex-div and collect the difference between the dividend and the time premium paid.

- There is no arb available for an ITM call because you lose the time premium paid if you do the arb (share price reduction offsets the dividend on the ex-div date).

The article in the following link suggest that you're likely to be assigned on a short ITM call if the ITM call and the same series put have the same amount of time premium.

It seems to me that there's something wrong with the example cited. Perhaps it is using bad numbers and the put would never trade for 10 cents? So my question is, is this a realistic example?

http://tastytradenetwork.squarespac...long-in-the-money-options-to-collect-dividend
 
-- Or, you could buy a put, buy the stock and sell an OTM call. But, the numbers won't add up for a retail trader. And, the time premium for puts will increase as the underlying approaches ex-dividend.

-- Yes, the dividend is offset by the markdown of the underlying; so, there's no point in exercising the call.

-- For me the easiest way of looking at it is that you are likely to be assigned if the dividend is greater than the remaining time premium of the call, and the greater the difference the more likely you are to be assigned.
 
When looking at whether to exercise a call for a dividend, its the price of the same strike put/vs the dividend that is important.

Remember that long stock is synthetically the same as being long a call and short a put. LS=LC SP. So if you are long a call and there is a dividend, if you exercise you call and buy the same strike put, you now have long stock and a long put, which as synthetically the same as what you had before (just long the call). So if the dividend is more then the put you are buying it makes sense to exercise, as you have the same position as before but have pocked some extra money.

Note that you will also have to factor in cost of carry of the stock when figuring out if this is worth it or not, as you may be paying more interest in carrying the stock vs the call. If the stock is hard to borrow it will also affect this calculation.
 
- Or, you could buy a put, buy the stock and sell an OTM call. But, the numbers won't add up for a retail trader. And, the time premium for puts will increase as the underlying approaches ex-dividend.

What you've suggested is a long stock collar and I don't see that as having any relevance to the dividend arbitrage that I asked about, retail or otherwise.


-- Yes, the dividend is offset by the markdown of the underlying; so, there's no point in exercising the call.

-- For me the easiest way of looking at it is that you are likely to be assigned if the dividend is greater than the remaining time premium of the call, and the greater the difference the more likely you are to be assigned.

There's two paragraphs are contradictory. There's no point in exercising the call but you are "likely to be assigned if the dividend is greater than the remaining time premium of the call"?

Can you provide and example that demonstrates what you're suggesting --> underlying price, put and call strike prices with premiums and the dividend?
 
Jeff82 said:
--
-- Yes, the dividend is offset by the markdown of the underlying; so, there's no point in exercising the call.
More...

This is completely incorrect. This is why it is necessary to exercise the call, as your call position will also be "marked down" after the dividend.

Consider a stock is trading at 20 and there is a $1 dividend. You own a 5 call that is expiring in a few days. The call will be trading parity at 15. If you don't exercise it, on the ex date, all other things the same, the stock will be marked down to 19 and the call will still be trading parity at 14 now. If you didn't exercise the call you will have lost that dollar. If you did exercise you would also have the $1 dividend.
 
spindr0 said:
It has been my understanding that:

- If there is a pending dividend and the time premium of an ITM put is less than the dividend then there's an arbitrage available. IOW, buy stock, buy put, exercise after ex-div and collect the difference between the dividend and the time premium paid.

- There is no arb available for an ITM call because you lose the time premium paid if you do the arb (share price reduction offsets the dividend on the ex-div date).

The article in the following link suggest that you're likely to be assigned on a short ITM call if the ITM call and the same series put have the same amount of time premium.

It seems to me that there's something wrong with the example cited. Perhaps it is using bad numbers and the put would never trade for 10 cents? So my question is, is this a realistic example?

http://tastytradenetwork.squarespac...long-in-the-money-options-to-collect-dividend
More...

the arb is if you are short the call and someone doesn’t exercise against you.

the arb on the put is if you are short the put and you don’t get exercised after the div, But that is generally really small as it’s a financing arb.
 
OptionsOptionsOptions said:
Wouldn't dividends be priced into the options?

  • Lower call premiums.
  • Higher put premiums.

No arbitrage opportunity.
More...
Dividends are priced in but the calls here are unique as they can be exercised early. They "should be" trading below parity, but they can't be due to the exercise opportunity.

There are several ways to arb this. The main way is to buy or sell a deep call vertical. You exercise all your longs and hope you skate on a few of your short calls.
 
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