Assignment and Ex-Dividend Date?

[tjlocke99]

Hello.

Recently I was researching what happens if I hold a covered call through earnings.

I came across this article on theoptionsguide.com

http://www.theoption...ered-calls.aspx

It discusses writing a covered call but shorting a DITM call to try to scalp the dividend.

It seems the reasons this strategy will not work is because it is likely you will be assigned on that DITM call.

However could someone explain to me how that would work? Let's take a hypothetical example:

GD ex-dividend date 10/3 for $.51 a share

Let's say GD is trading at $65.00

On 10/2 during the day you go long 100 shares and sell a $63 Oct call for $2.00 even.

On 10/3 the stock drops and closes at $64.50

What would happen regarding you being assigned? Also do you need to be long the shares on 10/2 or is getting long the shares on 10/3 sufficient to receive the dividend when it is payed?

Thank you!

[Marco]

Yes depending on the IV on the Oct option you'll most likely be assigned on the ITM call. So you are right - the described strategy won't work.

You need to hold the shares BEFORE the ex date to get the dividend. The assignment the night before will count as the shares being bought the day before the ex date so theses shares will be eligible for the dividend (that's the point of the exercise after all) even if your broker might only book the shares from the assignment on the ex date (it will be as of ex date -1).

If you have a deep ITM short call vs. the stock and the call gets assigned any stock move on the ex date won't affect you as you'll have no position (you deliver the stock position to the owner of the call who exercised you)

Hope that answers your questions, let me know if not.

M.

[tjlocke99]

Great answer Marco, thank you.

One thing I don't get is why someone would exercise their ITM option the night before the ex-dividend date? If they received $2.00 for the ITM call, then they exercise there call and they buy the stock for $63 and lose the $2.00 premium they received. HOWEVER in my example the next morning they have lost around $.50 in the value of the underlying stock. So they gain the $.51 dividend and lose almost the exact amount on the value of the stock?

[Marco]

ok we have a stock at 65$ a 63$ call and 0.50$ div.

well assuming on the ex date the stock just drops by the dividend amount (so goes from 65 to 64.50)

A) you are long the call and DONT exercise:

you own a call that is now worth 1.50$ so you lost 0.50$

B ) you exercise your call, buy the stock for 63$ and get 0.50$ dividend, you lose your call which was worth 2$. You own the stock at 62.5 (63 - 0.5 div) which is now worth 64.50 so you are up 2$ on that offsetting your 2$ loss on the option - so you are flat compared to down 0.5$ if you don't exercise.

any move on top of the 0.50$ on the ex date is normal market risk which you have as well with the call. However the call would have capped your loss at 2$ should the stock drop a lot the next day and then with the benefit of hindsight you shouldn't have exercised but it will cost you 0.50$ to keep that option for just a few more days - so most people will exercise.

Edited October 30, 2012 by Marco

[tjlocke99]

GREAT response Marco!

This makes me wonder though. I wonder if this can be a way to get a call option on at a discounted price if you buy the call the day before the ex-dividend date, you may be able to get it with almost no time premium. Of course it is likely this is already priced in.

Thanks again Marco!

[Marco]

GREAT response Marco!

This makes me wonder though. I wonder if this can be a way to get a call option on at a discounted price if you buy the call the day before the ex-dividend date, you may be able to get it with almost no time premium. Of course it is likely this is already priced in.

Thanks again Marco!

well the reason why the call has very little to no time value is that it will (very likely) die the next day.