SPECIAL DIVIDENDS – Be Especially CAREFUL

We’ve started to get a good number of e-mails and phone calls in The Options Institute from investors, financial advisors and traders about the “Special Dividends” being announced by corporations with payment in 2012. The question is “Are options affected, and if so, how”?

The Options Clearing Corp. (OCC) has two memo’s that are a MUST read if you have an options position (or are thinking of initiating one) in any of those stocks. Both memo’s state that “all adjustments are made on a case by case basis…”, but I’ll summarize them in a general manner as best I can (Bold, underlines, and italics are mine).

The first memo is OCC Infomemo # 31714. Adjustment Policy for Accelerated Dividends.

“… cash dividends which are paid pursuant to a company’s regular dividend payment program but which are subject to accelerated payment shall be deemed “ordinary” dividends. Ordinary dividends do NOT occasion (strike price) adjustment.  This is irrespective of the company’s characterization of such dividends as “special”… ‘.

An example of this will be Best Buy (BBY). They announced this morning that the regular dividend originally scheduled for January 2, 2013 will be moved up to December 31, 2012. Based on OCC # 31714 we would expect that nothing should happen to option strike prices.

 

The following is the more complex situation.

OCC infomemo # 30412. Changes to Cash Dividend Adjustment Policies. This is a six-page memo, the majority is Q & A.

(With) dividends paid outside of ordinary, The OCC will normally adjust for non-ordinary dividends unless the amount is less than $12.50 ($0.125 X 100 shares). So if XYZ declares a Special Dividend of $0.10 per share ($10.00), nothing should happen to option strike prices.

Most of the Special Dividends I’ve seen are for more than $0.10 per share. Let’s look at a real example. Costco (COST) closed yesterday at $104.30. They declared a Special Dividend of $7.00 per share, payable on December 18th. The January 100 strike put was trading near $1.25. If COST closed at $104.30 on the X-date, the shares would open at $97.30. Wouldn’t the 100 put be intrinsically worth $2.70?

NO. Expect COST strike prices to be adjusted lower by 7 points. So if you buy the Jan 100 put today, in a few weeks (after the Special Dividend) it should become the 93 strike put. If COST is at $97.30 the newly adjusted 93 strike put will still be $4.30 out-of-the-money. The Jan 110 call at $0.72 will then be the adjusted 103 strike call. To the untrained eye, it looks like there’s an arb with a stock like COST and an OTM put. Not really.

The OCC rule on Special Dividends was modified several years ago (from a much higher threshold). Special Dividends are fairly rare, and many investors and traders have never seen strike prices being adjusted like this before.

So be careful. I suggest strongly for you to read both of the above memo’s and monitor the OCC web site. You can call the OIC help desk too at 888-options.

Marty Kearney

Options Institute