Special Dividends SHOULD Trigger Option Strike Resets Per OptionUniversity.
From Option University: Sometimes corporations pay a special one-time dividend and, in these cases, they do cause adjustments to option strikes. Whenever a special dividend is announced, all call and put strikes are reduced by the amount of the dividend. On July 20, 2004 Microsoft announced a special $3 cash dividend. This was a special one-time dividend so the option strikes – calls and puts – were adjusted downward...the $30 put and call became a $27 strike ...this is done to assure that option investors are not financially hurt (or unfairly rewarded) because of a corporate action: split, merger, or special dividend--this way...calls and puts retain all of their intrinsic value after the split.
In both cases calls and puts are worth the same amount before the ex-date and after due to the adjustment...the special dividend does not affect their pricing...they shouldn’t be, and that’s why the strike prices are adjusted.
Is there a way to get some “free money”by buying a call and then exercising it to collect the dividend. Option University says no, and the example they use is call buyers exercising stock buys with their calls, and giving up time premium. They assume the time premium is more, that the special dividend price. They also do not discuss multitiered buys, sells, and available for next trade dollars in cash accounts, or early exercise of "American" options, which allow you once the call is sold, to exercise an option at ANY time.
If I've three dollars time premium in an option in the money, and the special dividend is MORE than the time premium, and I was a major stock house, I'd be on the lookout for just such instant arbitrage situations to exercise as soon as I could. Or if I were an option holder, I would exercise my option for just that purpose, closer to expiration, depending upon how I thought the stock would behave post dividend.
For sure, having just been exercised in early November and "lost" my shares (and got my November premium "early") when there was NO dividend, I expect it to get pretty wild in my account. Of course, that frees up money to do other stuff, as I have said before.
And what is the worst that is going to happen? I collect the dividend, and I collect the option premium, or have it protect me, at the new ex dividend price.
Which should be four and one half dollars less than the closing price of the previous day. Which should be the closing price at 8PM, not 4PM IMHO, but that is a wait and see scenario.
One thing is certain, this is going to get nuts, and for want of a phrase, it takes a village.
"Whenever a special dividend is announced, all call and put strikes are reduced by the amount of the dividend."
No, that's not necessarily the case. The dividend has to equal or exceed $12 per contract before anything is adjusted. ... or is it $12.50? Many times special dividends are declared that are not very big, so nothing's adjusted.
It's "the rules" against "I have seen" for these extraordinary events, isn't it?
Whole bunch of strawman experiential guides and determinations like "10%" of the value of the stock" triggers a "special meeting to decide" stock option price changes, (huh?) and any option sold against shares which is less than the total value of the dividend makes the shares subject to call, in which the folks who call away the stock are shooting for the dividend yield to be in excess of the time premium, minus the change in value the day the stock goes ex dividend (but only on alternate periods when there is a full moon and the tanna leaves are in bloom Universally)(sarcasm).
Current guestimates are written by folks who mix apples and oranges--big surprise dividends with magic ceilings and floors. My guesses are as good as anyone else's, and the site you're reading is filled with more "I done seen" than "written in stone".
There PROBABLY will be an adjustment to share option prices, but $4.50 does not exceed the legend/rule of thumb that there is something magic about 10% of the stock price triggering put or option strike price restructuring.
So where are we?
prior to ex date 5 Dec a whole bunch of folks won't have the div vrs ex div issue straight and be buying all the way to COB 6 December, and asking that question about a zillion times on this board, having done no research on the issue beforehand to include the simple googling of this board's positions.
a whole bunch of folks will want to dump ex div for any price in excess of $49 since the runup subsequent the announcement has already exceeded the divvy, a whole bunch of shorts will be scrambling to catch that lower number, and that number may not last more than five seconds.
and another whole bunch of folks won't understand the $4.50 decrease ex div day and will sell, the other group thinking the stock is on sale for any number of reasons and these two groups will be battling all day.
the stock will continue to have positive pressure in spite of that prior to ex divvy because folks are just getting the word, and the volume, is reflecting the divvy, but the stock remains under the radar (hard to believe),
the (retail) shorts are having a nervous breakdown because of the warranted or unwarranted runup (take your pick), the shares are still $6 shy of all time high, yet maintain a PE of 17-18 which is average, the company is running 6 days a week 365 (and really should hire more atheists and folks who celebrate the Sabbath on Saturday to handle Sunday workload) -- and more increases to productivity are due next year.
I could go on for hours. As usual, in attempts to be "fair" to option holders, the system is "unfair" to option writers if the option prices are adjusted downward.
Puts are supposed to go up when the stock takes a plunge, and options are supposed to go down when stocks take a plunge for any reason. But I have watched the market during some particularly heavy dividend related selloffs and NOBODY trades till the stock shows a trend. Option buyers don't generally even set a price till the market shows direction, and frankly I have seen folks wait to buy or sell a covered call for an HOUR after market opens and the first sale HOURS thereafter, up down or sideways.
We'll just have to wait and see. What I think will happen has too many variables--I do know this--if you've sold a covered call with a time premium lower than the dividend, whatever the market forces are, your platform, ETRADE/SCOTTRADE will probably look very hard at exercising that option early and taking the arbitrage position difference. You own at $50, you sold a call against your shares, say at $50 for anything less than $7.50, with the stock at say $53.01, giving you a time premium less than the dividend amount, you have a high probability of being called away, even if the strike month is July or January 2014 or whatever. Your platform has instant arbitrage capability and is capable of doing that ANY time after you have written a covered call against your shares.
Turns simple investing into a #$%$ #$%$ fight, doesn't it?