On August 8th, Apple stock traded ex-dividend. While this event had been anticipated by many holders of Apple shares as the company begins to pay out a portion of its cash hoard, it presents special challenges to option traders. This event is a good example of how you can avoid a common pitfall which can cost you money.
Here is a quick review of the basics:
Dividends are paid to shareholders of the common stock only. Call option holders have no rights to dividend payments.
The dates which are important for dividends are:
The most important day is the Ex-Date. This is the date the stock will first trade “without” the dividend for any new purchase and sales. Actually the business day prior to the Ex Date is critically important for option traders.
This is determined by the Record Date which is 2 business days later to account for settlement of shares. Trades executed on the ex date will settle on the day AFTER the record date. The Record date is the day which settled shares are allocated the dividend payments.
Payable Date – this is the day the actual dividend payment is made. The length of time between the Record date and the Payable Date can vary greatly between stocks. For example IBM’s payable date is 1 month after the record date while Apple’s payable date is 3 days after the record date. During the time between the ex date and the payable date your account will have a pending dividend payment.
Since options holders are not entitled to dividend payments, the day prior to the Ex-Date long Call option holders must decide whether it is economically better to hold the option or exercise it into long stock. Obviously only in the money call positions would be exercised. Also if the option has a bid significantly higher than the intrinsic or parity value it is likely not an exercise candidate. However if the option is in the money to such a degree that the call option bid is equal to parity (to the stock), that call option will likely be exercised. Further this means that short option positions will likely be assigned into short stock positions which means they will owe the dividend on the new short stock position.
What this means to option spread traders gets a little more complicated. Credit spreads typically are limited risk plays for which the maximum loss is equal to the difference between strikes less the premium you received. Debit spreads are typically limited in risk to the premium paid initially. When a dividend and a possible assignment occurs however those risk bounds go out the window. If I sold the 610 – 615 call spread for 4 dollars I would be wrong in assuming that my maximum loss was only 1 dollar. If I am assigned on the 610 call I would owe 2.65 dollars for the dividend and I actually could be out as much as 5.00 + 2.65 or 7.65 if the 615 calls were not also an exercise. This definitely changes the theoretical value of this spread. For those more complex traders boxes can be worth more than the difference between the strike prices. If you see something like “free money” in the options market it likely is a trap so beware!
Further, even if I am long a debit call spread, I have risk if my short leg is assigned (typically the day prior to the Ex date) and I am unable to exercise the long deeper ITM call option. In this case I would need to close the long call spread on the day PRIOR to the ex-dividend date.
The OH platform shows icons which alert our customers about upcoming dividends. Confirm the ex-dates with outside sources such as Yahoo Finance or Bloomberg and be aware of the special risks for in the money call options that dividends can present.