Share option pricing in lead up to dividend

What happens to option pricing (not the call/put options - but the ones listed on ASX linked with shares) in the lead up to the company paying a dividend??

In the lead up to healthy dividends, share prices often increase as people seek to benefit from receiving the dividend. However I assume option holders don't get the dividend so does the option price rise with the share price or does it factor in the subsequent fall when they go ex-div

For example if share price is currently $1.10 and options (say ex @ $1.00) are $0.12, if shares typically rise before div payment - say a 10 cent div taking them to 1.20 - will the options rise 10 cents as well - say to $.22 - or will they factor in the subsequent ex-div fall?

The only options I have bought have been on non-div paying mining stocks - does anyone have an example of options of div paying stocks?

thanks in advance...

56gsa said:

For example if share price is currently $1.10 and options (say ex @ $1.00) are $0.12, if shares typically rise before div payment - say a 10 cent div taking them to 1.20 - will the options rise 10 cents as well - say to $.22 - or will they factor in the subsequent ex-div fall?

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The cheeky answer is to say many Company Issued options are thinly traded so the spread will always be a little skewed :

Given the basic components of an options price are intrinsic value (ie a $1 option on a $1.10 stock has 10c intrinsic value) and extrinsic value (in simplified terms, volitility & time with a few variables such as interest rates and of course dividends) you would expect any option (in theory) to not drop in price below the intrinsic value, as it would otherwise represent an arbitrage opportunity and traditionally the market is fairly efficient in closing these out as quickly as possible.

Unfortunately company issued options tend to have their own individual terms of exercise so this tends to effect the pricing on an individual basis, in theory and option shouldn't drop below intrinsic value & as per your example above, depending on the circumstances, you'd expect a little extrinsic value as well which will be maintained in most market conditions.

Mofra said:

you would expect any option (in theory) to not drop in price below the intrinsic value, as it would otherwise represent an arbitrage opportunity and traditionally the market is fairly efficient in closing these out as quickly as possible.

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thanks mofra. i guess i'm wondering if people build into the intrinsic value the future fall when shares go ex-div... eg there is no arbitrage if options are 12c, and people know the share will fall to $1.10 ex-div even though shares may go to $1.20? Another way to look at it is people are buying the shares to get the div so there is no demand for the options?

is there anyway of getting a list of non-mining options and testing this?

decided to test this with WAM Capital - just released Dec07 options (WAMO) ex @ $1.80 - current WAM sp is $1.83, options at around 7cents

chart shows WAM has has good run into each of its last two divs (6&7c)... so my theory is options will run a bit but not the full 7 cents - but at these levels you can still make a good %... this assumes WAM holds above $1.80 of course but seems to be priced at bottom end of current NTA

next div due in April - hope market can hold till then...

Good luck 56gsa, will be worth watching with interest. Given there is a growing trend of dividend stripping within normal trading raks it is good to hear people thinking outside the square - for info ETOs tend to be a little more closely priced for stocks with upcoming dividends in terms of pricing in the dividend (yes I learnt this the hard way!)

well mofra - i can report a successful pilot!!

bought WAMO @ avge 6.1, and they went from 13 to 17 cents today before settling on 15, based on WAM sp of $2.00 that increased from $1.95 with announcement of 8c div. today

only wish now i'd committed more !

56gsa said:

What happens to option pricing (not the call/put options - but the ones listed on ASX linked with shares) in the lead up to the company paying a dividend??

In the lead up to healthy dividends, share prices often increase as people seek to benefit from receiving the dividend. However I assume option holders don't get the dividend so does the option price rise with the share price or does it factor in the subsequent fall when they go ex-div

For example if share price is currently $1.10 and options (say ex @ $1.00) are $0.12, if shares typically rise before div payment - say a 10 cent div taking them to 1.20 - will the options rise 10 cents as well - say to $.22 - or will they factor in the subsequent ex-div fall?

The only options I have bought have been on non-div paying mining stocks - does anyone have an example of options of div paying stocks?

thanks in advance...

Click to expand...

the option price in theory changes by its delta for small changes in the share price.at the money the delta is 0.5 so if share changes from $1.00 to $1.2 say the $1.00 strike call option will increase by 10c. if the option is further out of the money it goes up less as delta is less
e.g. a $1.40 strike call may have a delta of 0.25 so it only rises by 0.25*20c =5cents.deep in the money calls will move more like the share but you have to invest more to buy those options. options are priced to stay the same pre and post dividend but that only works if the share drops exactly by the dividend on ex-div day. often shares fall more than dividend e.g. RIO (occasionally even rise like CBA on occasions) on ex div day so trading options around ex div day is tricky .also actual dividends expected can be quite different to what is later announced by the company and the ex div day can change after you have sold/ bought them thus the traders can lose out. I noted WPL at the last minute changed the ex div day from after option expiry to same day as expiry catching a lot out unfairly as the option price is quite different or you could be assigned the shares (sold puts) when you didn't expect to be. nothing you can do.
Sold Calls in particular can be exercised just before ex div day and this is not usually helpful unless you have the right number of shares shares for the option contracts sold. you then don't get the dividend. moral: buy calls 1 month before ex div then as share rises sell them before ex div day when you have some profit, or sell puts 1 month out and buy back (at lower price as shares rise towards dividend day)
BEFORE ex div .Plan b: sell options (usually OTM puts )with expiry much further away than ex div date so exercise won't happen.