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The owner of a long call for a stock is entitled to a dividend only if the option is exercised prior to the ex-dividend date, which is usually a few days prior to the record date. The record date is the date upon which a company ascertains who its shareholders are to either provide a dividend payment or allow shareholders to take other types of corporate actions.
The ex-dividend date is the deadline for the exchange to own the stock to receive the dividend. It is prior to the record date. This allows the exchange time to process the paperwork necessary to send out to the shareholder, along with the dividend.
Key Takeaways
- Owning a long call (a right to buy a stock) does not entitle the holder to the underlying stock’s dividend unless the option is exercised before the ex-dividend date. This is crucial for investors seeking dividend income.
- The ex-dividend date is the critical deadline for stock ownership required to receive a company’s dividend. It occurs before the record date, which is when a company establishes who will receive the dividend.
- The value of a stock typically increases by the dividend amount up to the ex-dividend date but falls by that amount on the ex-dividend date itself. This reflects market expectations and adjusts option and stock prices accordingly.
- Different option strategies capitalize on dividend-related price movements. For example, a covered call strategy involves buying the stock and selling calls, while dividend arbitrage involves buying the stock and deep in-the-money puts.
How Long Calls Impact Dividend Entitlements
The long call represents the right to purchase the shares of the underlying stock for a certain amount of time. Unless exercised, it does not confer the same benefits as owning the stock outright. American-style options can be exercised at any time prior to expiration. This is different from European-style options, which can only be exercised on their expiration date.
The dividend payment has an impact on both the pricing of options and the underlying stock. Generally, the price of a stock goes up an amount equal to the dividend amount until the ex-dividend date. On the ex-dividend date, the market expects the stock to drop by the dividend amount since any buyer on that date is not entitled to the distribution. The stock is then worth the amount it was the day prior to the ex-dividend date, less the amount of the dividend.
Trading Strategies Around Ex-Dividend Dates
Some option strategies seek to capitalize on the price action of stock around the ex-dividend and record dates. One strategy is a type of covered call trade. Before the ex-dividend date, a trader can buy the stock and then write deep in the money-covered calls against the stock. The trader makes sure that the calls are equal in value to the stock purchased. Deep in the money calls have a high delta near 1, which means they move nearly equal to the stock’s movement. As the stock price drops on the ex-dividend date, the sold calls drop a similar amount, resulting in a profit on that portion of the trade. The trader can then buy the short calls back and not lose any capital on the stock price drop.
Another type of strategy is a dividend arbitrage trade. A trader buys the dividend-paying stock and put options in an equal amount before the ex-dividend date. The put options are deep in the money above the current share price. The trader collects the dividend on the ex-dividend date and then exercises the put option to sell the stock at the put strike price. This can earn profits with very little risk for the trader, hence the arbitrage type of strategy.
