## Monday, April 22, 2013

### Options 2.0 – Part 17. Dividend & early exercise call options - part 2

Dividend & early exercise call options – part 2

Let’s return to the Ahold example of last week, Thursday, April 11th, 2013.

Be careful with dividend!
Last week we revealed that there is only one optimal moment to exercise call options early: on the last trading day before the ex-dividend date. According to certain criteria, a call option is ‘early exercise' and you're better off financially if you receive the dividend or sell the call option before the ex-dividend date.
By going ex-dividend you also prevent a value decrease in the call option. Such a value decrease results in unnecessary loss.

Real life scenario: Ahold is listed ex-dividend today
This morning (April 19th), Ahold shares are listed ex-dividend. The dividend amount is EUR 0.44. Yesterday Ahold closed at EUR 11.71. Subtract the dividend amount of 0.44, and you arrive at a theoretical opening price of 11.71 - 0.44 = 11.27. And that’s what you see reflected in the actual opening price: Ahold opened this morning at 11.33 (a minus of 0.38). The latest price (at the time of writing this article) at 09:10 is 11,265. That’s 0.445 less than yesterday's closing price. You see: that’s roughly equivalent to the dividend amount of 0.44. Take a look at our sample calculation in the table below:

What does this mean for Ahold Options?
If you were long in Call options that were ‘early exercise' yesterday, then this would cost you money today. Calculate it:
Call Apr-13 10.50 will go from a closing price of 1.21 to a bid price of 0.75. That’s 0.46 lower.
Call Apr-13 11.00 will go from a closing price of 0.71 to 0.26. That’s 0.45 lower.
Call Apr-13 11.50 will go from a closing price of 0.21 to 0.03. That’s 0.18 lower.

If you were long on one of these options series yesterday, then you would see a significantly lower value on your screen this morning. This could easily have been prevented by:
• Exercising these ‘early exercise’ options early on the last trading day before ex-dividend (so yesterday). You’ll receive the shares and today, obtain a dividend of EUR 0.44 per share.
• Or you could have sold the options before the ex-dividend date.
So, one thing you as an options investor shouldn’t do is: stay long on ‘early exercise’ call options and silently hope that the dividend will catch up. This can be a good strategy if you invest in shares, but not when you invest in options.

Ex-Dividend in conclusion
If you’re long in ‘early exercise’ call options on the last trading day before ex-dividend, exercise these options early or sell them. I hope that the impact of dividend and ex-dividend is much clearer now!

Dividend Agenda:
Next week, the following option classes will go ex-dividend:
·       Corio EUR 2.76 dividend, ex-dividend 22nd April
·       Ten Cate EUR 0.50 dividend, ex-dividend 22nd April
·       BinckBank EUR 0.28 dividend, ex-dividend 24th April
·       Wereldhave EUR 3.30 dividend, ex-dividend 24th April
·       ASML EUR 0.53 dividend, ex-dividend 26th April
·       BAM Groep EUR 0.10 dividend, ex-dividend 26th April
·       Vopak EUR 0.88 dividend, ex-dividend 26th April
·       Wolters Kluwer EUR 0.69 dividend, ex-dividend 26th April

Please note that this example is for illustration and education purposes only and does not incorporate transaction costs. This example is not a recommendation.

Herbert Robijn is founder and director of FINODEX (www.finodex.com). FINODEX develops innovative online investment tools for private equity and options investors. These cutting-edge tools allow investors to make a comprehensive market analysis, complex calculations and appropriate selections, at just the touch of a button.

## Saturday, April 13, 2013

### Options 2.0 – Part 16. Dividend & early exercise call options

Dividend & early exercise call options
The dividend season has begun. This is particularly important for investors, because the receipt of dividends can generate income. And if you're an options investor? Then you’d better watch out.

Dividend – important for the value of options
Dividend is one of the 6 parameters that directly affect the valuation of options. This is actually when it all starts to happen: it’s extremely difficult for private investors to unravel which shares go ex-dividend and when, and how big the dividend amount will be. On the ex-dividend day the share price will open, minus the dividend amount.

Early Exercise: when exactly?
Amsterdam share options are American style. American style options may be exercised early. But what happens to your call option position if you exercise them early? And when precisely should you do that?
There is in principle only one optimal moment to exercise call options early: on the last trading day prior to the ex-dividend date. And that only applies to in-the-money call options, where the remaining call option time value is smaller than the dividend amount to be received. In this case, a call option with a short maturity is 'early exercise' and you are financially better off if you receive the dividend or sell the call option before the ex-dividend date. Also, by going ex-dividend, you’ll prevent a decrease in the value of the call option. Such a decrease in value results in unnecessary loss. For call options with a long maturity it’s slightly more complicated, as you must also take the interest component into account.

A Sample Calculation
An Ahold share is listed at 12.055 upon closing (11th April).
Ahold is intending to go ex-dividend on 19th April, with a dividend amount of 0.44.
The call 17-May-13 11.00 has a (bid price) of 1.02 - (ask price) 1.07.
This call option now lists under parity; the intrinsic value of 1.05 (= share price of 12.055 - call strike price of 11.00) is higher than the price that you receive for the call option. And there is a negative remaining time value (-0.035).

So, where is the profit if you have call options?
If you exercise this Ahold call option early, so at the optimum moment of one trading day before ex-dividend, then you’ll get the dividend and receive the dividend amount of 0.44. You’ll have effectively 'swapped' your call for shares. And the dividend amount will be considerably higher than the remaining time value of the call option. Of course, as the owner of a call option, you’ll naturally receive no dividend. You should definitely calculate it because you can really earn extra money by exercising early. In this example (on the last trading day before ex-dividend), you buy shares for the strike price of 11.00 and voila, you list them the following day for 0.44 dividend. You would never have achieved this, had you maintained your long call option position. If you don’t want any Ahold shares and dividend, then it’s wise to sell the call option before the ex-dividend date because the value of the call option increases considerably ex-dividend. And that results in unnecessary loss.

Are you long or short?
If you own call options (you are "long") and you exercise them early, then you lose the remaining time value. You can then buy the shares at the level of the strike price, because you (by definition with call options) have the right to buy. The shares that you receive at the strike price can subsequently be sold for the current market price of the share. The dividend receivable must therefore outweigh the remaining time value that’s left to run. Otherwise you’re better off just selling the call option.

If your call options are 'short' and the counterparty exercises the call option early, then it is you who is obliged to deliver the shares at the level of the strike price. With a short call, you have a delivery obligation. Note: if you don’t have the shares in your possession, then you must first purchase them for the current share price.

European Style Index Options
Index Options in Amsterdam are European style. And that means that you cannot exercise them early. Which results in the following situation: an AEX-index call option with a shorter maturity has higher option premiums than an AEX index call option with the same strike price and a longer maturity. Take a look at the option price of the in-the-money calls AEX 340.00 for April and May 2013 expiration. And notice the negative difference. This is due to the expected dividend between April and May expiration of 5.68 index points.

Dividend Agenda
Keep a close eye on the dividend calendar. Below, we’ve supplied both the AEX and AMX expected dividends for the following two weeks:
• TNT Express EUR 0.03 dividend, ex-dividend date 12-Apr-13
• Wessanen EUR 0.05 dividend, ex-dividend date 18-Apr-13
• Ahold EUR 0.44 dividend, ex-dividend date 19-Apr-13
• Heijmans EUR 0.25 dividend, ex-dividend date 19-Apr-13

Don’t want to miss a thing and prefer to receive a weekly Dividend Update?

Simply send me an email and I'll add you to the weekly "Dividend Update" mailing list. Because convenience is an investors best friend.

Please note that this example is for illustration and education purposes only and does not incorporate transaction costs. This example is not a recommendation.

Herbert Robijn is founder and director of FINODEX (www.finodex.com). FINODEX develops innovative online investment tools for private equity and options investors. These cutting-edge tools allow investors to make a comprehensive market analysis, complex calculations and appropriate selections, at just the touch of a button.