Exercising Call Options for the Dividend

Is there any circumstance where I would lose the dividend by writing covered calls?



Yes there is that possibility. 

When you sold the call option, you granted to the buyer the right to purchase your shares by paying the strike price per share.  The option owner may elect to do that (by exercising the call option) at any time prior to expiration.  You have no say in the matter. You cannot force the call owner to
exercise, nor can you prevent it.

As soon as the option is exercised, the option owner is considered to have bought the shares.  As with a traditional stock purchase, the stock trade settles three days later.  As long as the option is exercised (and you are assigned an exercise notice), the stock has been sold. 

If this exercise occurs before the stock trades ex-dividend (without the dividend), then the trade settles in time for the person who exercised the option to be declared the stockholder of record when the stock trades ex-dividend, and hence, collects that dividend.  You, as the former shareholder do not get that dividend.

The larger the dividend, the greater the possibility of losing the dividend.

Also, the closer ex-dividend date is to expiration, the greater that possibility.  

One point must be mentioned.  No one will exercise an option that is not in the money.  And the option must be sufficiently in the money before it's owner will exercise.  Why? 

The call owner has a limited liability.  If the stock tumbles, the maximum loss is the value of the call option.  Once the exercise is complete, the former option owner now owns stock.  If the stock tumbles, the loss can be large – much larger than the loss experienced by the option owner.  Thus, the call must be far enough in the money that the person who exercises is willing to take the risk of owning stock instead of the call option.  The break point comes at the strike price of the option.  The exerciser must be willing to bet – and the payoff is the dividend – that the stock will not tumble below the strike price – where the loss can be substantial.

When exercising, the best time is one day before the stock trades ex-dividend.

You learn about being assigned an exercise notice the morning after the option owner exercises. Thus, if you see that you still own the shares on the morning the stock goes ex-dividend, then you collect the dividend. When  you no longer own the stock, and are no longer short the call option, on that ex-dividend day, then you do not collect the dividend.  How can you determine the likelihood of being assigned for that dividend?  If the call option is trading at parity – and that means it has zero time premium – and if the delta is 100, then it's right for the call owner to exercise.  Some call owners exercise more aggressively, but that is beyond your control.


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4 Responses to Exercising Call Options for the Dividend

  1. jeff partlow 03/19/2010 at 3:20 PM #

    One additional point of clarification for you:
    It is normally in the call option owner’s economic interest to exercise early only if the stock is in-the-money the day prior to the ex-div date AND the ex-div amount is greater than the remaining extrinsic value (i.e. time value) in the call option.

  2. Mark Wolfinger 03/19/2010 at 4:41 PM #

    I don’t know how or where you arrived at your misconception, but that is not a clarification. It is a falsification.
    If the option has ANY time premium, it is economically wrong to exercise for the dividend.
    The following morning, if the stock is unchanged, the call option will carry a time premium GREATER than the dividend.
    That means the covered call writer who was assigned can re-establish the position at a profit.
    For example, pay the $0.50 dividend and write the covered call (strike price = 60) at a net debit of $59.20. That’s free money.
    I admit that sometimes the extra profit is not enough to offset commissions, but one thing is true: The person who exercised the option lost money. (Selling the option at 80 cents over parity beats collecting the fifty cent dividend)

  3. Vittorio Calcagno 04/01/2010 at 7:22 PM #

    If the day before ex-dividend the call contract is trading with any time value (extrinsic value), which is anything more than S-X (S= stock price, X = exercise/strike price) then the call owner is better of closing the contract (selling the call) and buying the stock, if the desire is to hold the stock. This will create the exact same result as exercising the call, and still capture the time value portion that the call has.
    At the day before ex-dividend date…
    A call with Strike = 100 is trading for 5.50 when Stock = 105.
    This call has a intrinsic value of S-X = 5, and time value of 0.50 (Call price – intrinsic).
    Alternative A – Sell the contract, buy the shares
    Sell the contract: +5.50
    Buy share: 105
    Net expense: 105-5.50 = 99.50
    Final result for portfolio: You end holding a long stock before ex-dividend date.
    Alternative B – Exercise the contract
    By exercising the call you buy the share for X, so…
    Buy share: 100
    Net expense: 100
    Final result for portfolio: You end holding a long stock before ex-dividend date.
    Notice how the final result is the same by selling the contract and buying the shares or exercising the call contract: you end up holding the stock before the ex-dividend date. But by selling the call that is trading with some time value (which is almost always true for highly traded options) the investor is able to capture the time value and reduce the net cost of buying the stock.
    Incorporate the Bid/Ask spread and transaction fees to make this calculation more accurate.
    Rule of thumb: Don’t exercise a call that is trading above intrinsic value if your intent is to hold a long position on the stock. You are better of closing (selling) the call and buying the underlying stock.

  4. Mark Wolfinger 04/01/2010 at 7:28 PM #

    Thank you Vittorio,
    Didn’t I say that in my response above?
    I appreciate the clarification and the time required to compose your comment.