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Wednesday, March 28, 2007

Options Trading Question

I was explaining option trading to a friend and came up with a question that I don't know the answer to. Perhaps someone out there can help me.

The question concerns how dividends are handled in an option contract. Suppose it is now March and I write a covered call with a May expiration. In April, the stock pays a dividend. In May, the option is in the money and is exercised. Who keeps the dividend? It was paid to me in April, since I held the stock then, but if the option is exercised, do I have to pay the dividend to the new stock owner?

The last covered calls I wrote were for SFI, a dividend paying stock, but no dividends were paid between the time I sold the option and the expiration date, so I did not face this problem. However, if I decide to write some longer term covered calls, this issue will come into play.

2 comments:

Doug O said...

Shaun, when selling covered calls, dividends should be factored into the price prior to sale (ie, the market generally accounts for any dividends scheduled prior to expiration)... If you sell covered calls, you still own the stock, and as long as you still own the stock past the ex-dividend date, the dividend is payable to you (even if other person chooses to exercise the option after the ex-dividend date)...
Occasionally, you'll have someone who will exercise their option early, prior to the ex-dividend date. In that situation, you would lose the stock and the dividend...
Since a stock almost always goes down after a dividend is paid, if it is near being in the money, this could actually help you retain the stock if your calls are not exercised early... Hope that helps..

Shaun said...

That helps! Thanks!

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