What happens to option priceing when there is a specifial dividend

[jasonw1]

Let's say I have call option on a 10$ stock, and the company is planning to hand out a one time, special dividend of 3$, what happens to the option price? Will it get adjusted for the 3$ or option holders just get screwed? Where can I find out this information?

 

Thanks

[twacowfca]

Let's say I have call option on a 10$ stock, and the company is planning to hand out a one time, special dividend of 3$, what happens to the option price? Will it get adjusted for the 3$ or option holders just get screwed? Where can I find out this information?

 

Thanks

 

 

Can you find a screwdriver that goes in reverse?  :)

 

BS and other option pricing models normally adjust for regular dividends, but not special dividends.  However, it's possible that the invisible hand of the market has made some adjustment.  Keep an eye on the price of the option and the implied volitility as it approaches and then goes ex div. Sudden change in the price of the option could be modulated somewhat by Mr. Market -- or maybe not.  If it's a very short dated call that's at the money or out of the money, it could be toast once it goes ex div.

[jasonw1]

I decided to avoid the uncertainty and just use the common shares. Thanks for the information!

[valuecfa]

Option prices are adjusted for special dividends. They don't get adjusted for regular divis.

[twacowfca]

Option prices are adjusted for special dividends. They don't get adjusted for regular divis.

 

That's interesting.  Black Scholes option pricing models include the regular dividend rate as part of the formula, so in a sense the formula "adjusts" for the regular dividend rate.  Are you saying that the exchange or the specialist or market maker makes a manual adjustment, as for example to the strike price, when a special dividend is paid?  If so, that makes sense, and I stand corrected.

[valuecfa]

Option prices are adjusted for special dividends. They don't get adjusted for regular divis.

 

That's interesting.  Black Scholes option pricing models include the regular dividend rate as part of the formula, so in a sense the formula "adjusts" for the regular dividend rate.  Are you saying that the exchange or the specialist or market maker makes a manual adjustment, as for example to the strike price, when a special dividend is paid?  If so, that makes sense, and I stand corrected.

 

Yeah, they just adjust the strike when a special dividend is paid. It used to be a 10% of market value divi was considered "special". The rules changed recently to being "special" if the divi/contract is at least $12.50 or greater. Tricky or iffy situations where the divi/contract is higher than $12.50, yet consistently pays the divi quarterly are voted on by a panel, as to whether or not they will be "special." Old options are still grandfathered in under the old 10% rule.

[twacowfca]

Option prices are adjusted for special dividends. They don't get adjusted for regular divis.

 

That's interesting.  Black Scholes option pricing models include the regular dividend rate as part of the formula, so in a sense the formula "adjusts" for the regular dividend rate.  Are you saying that the exchange or the specialist or market maker makes a manual adjustment, as for example to the strike price, when a special dividend is paid?  If so, that makes sense, and I stand corrected.

 

 

 

 

 

Yeah, they just adjust the strike when a special dividend is paid. It used to be a 10% of market value divi was considered "special". The rules changed recently to being "special" if the divi/contract is at least $12.50 or greater. Tricky or iffy situations where the divi/contract is higher than $12.50, yet consistently pays the divi quarterly are voted on by a panel, as to whether or not they will be "special." Old options are still grandfathered in under the old 10% rule.

 

 

Well, in that case, the special dividend case presented by jasonw1 wouldn't reach the threshold for adjustment to the strike price.  What about rights offerings below the strike?  How are they handled by the exchange or exchanges?

[valuecfa]

Option prices are adjusted for special dividends. They don't get adjusted for regular divis.

 

That's interesting.  Black Scholes option pricing models include the regular dividend rate as part of the formula, so in a sense the formula "adjusts" for the regular dividend rate.  Are you saying that the exchange or the specialist or market maker makes a manual adjustment, as for example to the strike price, when a special dividend is paid?  If so, that makes sense, and I stand corrected.

 

 

 

 

 

Yeah, they just adjust the strike when a special dividend is paid. It used to be a 10% of market value divi was considered "special". The rules changed recently to being "special" if the divi/contract is at least $12.50 or greater. Tricky or iffy situations where the divi/contract is higher than $12.50, yet consistently pays the divi quarterly are voted on by a panel, as to whether or not they will be "special." Old options are still grandfathered in under the old 10% rule.

 

 

Well, in that case, the special dividend case presented by jasonw1 wouldn't reach the threshold for adjustment to the strike price.  What about rights offerings below the strike?  How are they handled by the exchange or exchanges?

 

Jason's hypothetical example would qualify for adjustment since it meets the $12.50 threshold (Assuming it is not an old option that was grandfathered under the old rule. If it is an old option than i would have to know the market cap of the company to determine if it were a special dividend). As for the rights offering, there usually isn't any adjustment other than the right to delivery of the rights that were issued.

 

[twacowfca]

Option prices are adjusted for special dividends. They don't get adjusted for regular divis.

 

That's interesting.  Black Scholes option pricing models include the regular dividend rate as part of the formula, so in a sense the formula "adjusts" for the regular dividend rate.  Are you saying that the exchange or the specialist or market maker makes a manual adjustment, as for example to the strike price, when a special dividend is paid?  If so, that makes sense, and I stand corrected.

 

 

 

 

 

Yeah, they just adjust the strike when a special dividend is paid. It used to be a 10% of market value divi was considered "special". The rules changed recently to being "special" if the divi/contract is at least $12.50 or greater. Tricky or iffy situations where the divi/contract is higher than $12.50, yet consistently pays the divi quarterly are voted on by a panel, as to whether or not they will be "special." Old options are still grandfathered in under the old 10% rule.

 

 

Well, in that case, the special dividend case presented by jasonw1 wouldn't reach the threshold for adjustment to the strike price.  What about rights offerings below the strike?  How are they handled by the exchange or exchanges?

 

Jason's hypothetical example would qualify for adjustment since it meets the $12.50 threshold (Assuming it is not an old option that was grandfathered under the old rule. If it is an old option than i would have to know the market cap of the company to determine if it were a special dividend). As for the rights offering, there usually isn't any adjustment other than the right to delivery of the rights that were issued.

 

 

 

My bad. I was squinting at fine print on my i phone and misread Jason's price.

 

Re. adjustment for rights offerings, in 06 USG had a rights offering that doubled their shares outstanding.  The rights were for $45 per share when the stock was selling for more than twice that amount.  The exchange implicitly lowered the strike prices of the outstanding options that expired after the record date for the rights offering, to about half the previous price by doubling the number of shares from 100 shares per contract to 200 shares upon settlement after the effective date.

 

Is this type of adjustment, increasing the number of shares per contract, rare and only done in extreme circumstances?  Thanks for your patience, valuecfa while answering all these questions.  :)

[valuecfa]

Option prices are adjusted for special dividends. They don't get adjusted for regular divis.

 

That's interesting.  Black Scholes option pricing models include the regular dividend rate as part of the formula, so in a sense the formula "adjusts" for the regular dividend rate.  Are you saying that the exchange or the specialist or market maker makes a manual adjustment, as for example to the strike price, when a special dividend is paid?  If so, that makes sense, and I stand corrected.

 

 

 

 

 

Yeah, they just adjust the strike when a special dividend is paid. It used to be a 10% of market value divi was considered "special". The rules changed recently to being "special" if the divi/contract is at least $12.50 or greater. Tricky or iffy situations where the divi/contract is higher than $12.50, yet consistently pays the divi quarterly are voted on by a panel, as to whether or not they will be "special." Old options are still grandfathered in under the old 10% rule.

 

 

Well, in that case, the special dividend case presented by jasonw1 wouldn't reach the threshold for adjustment to the strike price.  What about rights offerings below the strike?  How are they handled by the exchange or exchanges?

 

Jason's hypothetical example would qualify for adjustment since it meets the $12.50 threshold (Assuming it is not an old option that was grandfathered under the old rule. If it is an old option than i would have to know the market cap of the company to determine if it were a special dividend). As for the rights offering, there usually isn't any adjustment other than the right to delivery of the rights that were issued.

 

 

 

My bad. I was squinting at fine print on my i phone and misread Jason's price.

 

Re. adjustment for rights offerings, in 06 USG had a rights offering that doubled their shares outstanding.  The rights were for $45 per share when the stock was selling for more than twice that amount.  The exchange implicitly lowered the strike prices of the outstanding options that expired after the record date for the rights offering, to about half the previous price by doubling the number of shares from 100 shares per contract to 200 shares upon settlement after the effective date.

 

Is this type of adjustment, increasing the number of shares per contract, rare and only done in extreme circumstances?  Thanks for your patience, valuecfa while answering all these questions.  :)

 

No problem. I love chatting about stuff like this.

 

I googled around to find this contract adjustment for USG in 06 for a rights offering. Maybe it will help:

http://www.optionsclearing.com/components/docs/market-data/infomemos/2006/feb/21406.pdf

 

As you can see, there was no change in the strike, multiplier, or number of contracts. Just where the old contract called for delivery of 100 shares of USG. The new adjusted contract called for delivery of 100 shares of USG plus 100 rights to purchase 1 USG share per right. If a call option, for example, is excercised, then the shares plus the rights have to be delivered.

 

It goes on to say...

 

If USG distributes the Rights at a time when the price of USG stock is

substantially above the exercise price of the Rights, the Rights will have

substantial value, and the stock price may fall sharply on the ex-date for the

distribution. If USG options are adjusted as indicated above, the Rights will be

part of the USG options deliverable, but only until the Rights expire. When the

Rights expire, they will become worthless and any value the Rights had will be

lost. As a result, holders of in-the-money calls may be disadvantaged unless they

exercise in sufficient time to obtain the Rights. After the Rights expire, holders of

short put positions who are assigned will be required to purchase USG stock

whose value may have been substantially diminished by the Rights distribution.

 

 

Edit: By the way in Jason's example, i was kinda vague. Assuming it is a standard contract...

You have to go by the divi/contract, not divi/share. So, in his example it was 100x3= $300. 

$300 > $12 = special

[twacowfca]

Many thanks, again, valuecfa for your most helpful answers.  Do I understand correctly from your latest post about the threshold for adjustment for special dividends being based on the actual contract, that an adjustment would normally be made for special dividends that are not particulaly large as a percentage of the market price of a share of the stock?  Thanks in advance for your helpful insights.