The Option Dividend Effect
Original post by Michael Wolfe of Demand Media
Employees, investors and other parties often purchase or are granted stock options in a particular company. Options can be either "call" or "put" options, meaning that the holder is given the right to buy (call) or sell (put) the company's stock at a designated price. For a call option, the announcement of a dividend will raise the option's price, and it will cause the price of a put option to fall.
A dividend is a payment that a company makes to its shareholders representing profits earned by the company. The amount of the dividend depends on its policies as well as its financial success during a particular accounting period. Usually, dividends are paid quarterly. A stockholder receives a dividend for every share of stock owned, which means that larger shareholders profit more from dividend payments than others.
If a company announces an unexpected dividend, or the dividend announced is larger than the market expected, the company's share price will typically go up. This is because the market is factoring into the price of the stock the amount that the stockholder will receive when the dividend is paid. Conversely, if the dividend is less than the market expected, this news can cause the stock price to go down.
The price of an option is directly related to a company's stock price. If the option is a call option, then the two share a direct relationship: as the price of the stock rises, the price of the option also rises. With a put option, a rise in the stock price will make the option less valuable. Dividends, unless they are less than the market expected, will cause a call option to rise in price.
Once a dividend has been announced and paid, the price of the stock option drops again, as the dividend is no longer a factor in the price of the stock. This is because, once an investor has been paid, the stock no longer reflects the expectation of the dividend. Consequently, the boost in the option price caused by the dividend is only temporary.
- The Options Guide: Effect of Dividends on Option Pricing
- CallWriter.com; How Stock and Option Prices React to Dividends; John Brasher
About the Author
Michael Wolfe has been writing and editing since 2005, with a background including both business and creative writing. He has worked as a reporter for a community newspaper in New York City and a federal policy newsletter in Washington, D.C. Wolfe holds a B.A. in art history and is a resident of Brooklyn, N.Y.