Equity option pricing dividends
Most people are aware that when a company pays a dividend, the price of its stock is equity option pricing dividends to drop by roughly the amount of the dividend.
This has special implications for option trading. The reason that a stock drops after a dividend is equity option pricing dividends clear. To see why, imagine that it was not expected to happen. Whoever owns the stock at the close of business on the trading day before the ex-dividend date, December 20 in this case, will receive the dividend two weeks later.
Whoever buys it on or after December 21 will buy it ex-dividend without the dividend. He would then be on the books as the owner and would receive the dividend a few weeks later, on the payment date. It is not necessary, by the way, to own the stock on the payment equity option pricing dividends to equity option pricing dividends the dividend. The demand for the stock in the few days before the ex-dividend day would go up as people bought to acquire the dividend.
Then the next morning when all the people who were following that strategy sold their shares, the excess supply would push the stock back down again, about to where it started. What actually happens is that the closing stock price on equity option pricing dividends day before the ex-dividend date is adjusted downward by the amount of the dividend. Below is a real-life equity option pricing dividends.
For options, this expected drop in the stock price has particular implications. If a specific change in the stock price can be reasonably expected, then it will be built into the prices of the options on that stock ahead of time.
Then, when the dividend date arrives the option prices will realign to remove the adjustment for the anticipated dividend which is now in the past. When the price of a stock goes down, all of its call option prices will go down and all of its put option prices will go up. If a drop in the stock price is anticipated because of a dividendthen that expected drop makes all the call prices lower than they would otherwise have been, ahead of time.
It also makes all the put prices higher than they otherwise would have been. Option trading is a powerful way to profit from your market outlook. Knowing the role of dividends can give you a strong edge. Disclaimer This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk.
The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter.
Future results can be dramatically different from the opinions expressed herein. Past performance does equity option pricing dividends guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.