Understanding 1-Time Special Cash Dividends and Our Current Trade Status: A Real-Life Example with OMF – January 17, 2022
Contract adjustments will change the parameters of our covered call writing and put-selling trades but will not result in any trade loss or gain. The Options Clearing Corporation (OCC) will make alterations to our option contracts such that buyers and sellers of calls and put are made whole after the corporate event. On August 6, 2021, Richard wrote to me expressing his concern over a covered call trade he executed with OneMain Holdings, Inc. (NYSE: OMF). On August 5th, OMF has an ex-dividend date for both the regular quarterly dividend of $0.70 per-share and a special 1-time cash dividend of $3.50 per-share. The $61.50 strike he sold initially was changed to $58.00 on the ex-date. To mitigate what was perceived as a losing situation, the trade was unwound “at a small loss” and a decision was made never to sell options prior to an ex-date moving forward. This article will evaluate the trade status after the ex-date as well as the action and trading decisions resulting from the contract adjustment.
What is a contract adjustment?
These are changes to option contract terms due to underlying corporate actions like stock splits, mergers and acquisitions and special cash dividends.
Initial trade structuring
- 7/19/2021: Buy OMF at $61.00
- 7/19/2021: STO the 8/20/2021 $61.50 call at $2.00
- 8/6/2021: Ex-dividend date for the $0.70 regular and $3.50 special 1-time cash dividends
- 8/6/2021: The $61.50 strike is adjusted to a $58.00 strike
- 8/6/2021: Both legs of the covered call trade were closed at a small loss
OCC publication of the contract adjustment
Current trade status as of the 8/5/2021 ex-date
There are no contract adjustments for the regular $0.70 dividend. These are expected and already baked into the option premiums. The 1-time special cash dividend is another story. Since the value of a stock will drop by the dividend amount, the corresponding option strike prices should also be decreased by the dividend amount, $3.50 in this case. Since that dividend will be captured by the covered call writer on the distribution date, having the strike reduced results in neither a trade loss or gain. The OCC makes sure that we are made whole.
On 8/6/2021, OMF closed at $58.35 leaving the $58.00 call slightly in-the-money, a favorable position for Richard.
Discussion
Option contract adjustments will result in neither a total position gain nor loss. The OCC will make sure buyers and sellers of calls and puts remain at the same pre and post ex-date statuses.
Author: Alan Ellman