How Our Covered Call Trades are Impacted When Regular and Special 1-Time Cash Dividends Come on the Same Day – August 28, 2023
The parameters of our covered call trades are often changed when certain corporate events result in option contract adjustments. These events include stock splits, mergers & acquisitions as well as special 1-time cash dividends. This article will analyze a real-life example with Ford Motor Company (NYSE: F) and how a regular dividend, a special 1-time cash dividend and a covered call trade resulted in contract adjustments.
F Trade data
- 2/8/2023: F trading at $13.48
- 2/8/2023: The 2/24/2023 $13.50 call is in place
- 2/8/2023: The bid – ask spread for the $13.50 call is $0.32 – $0.34
- 2/10/2023: This is the ex-dividend date for a regular dividend of $0.15 as well as a special 1-time cash dividend of $0.65. This will result in a contract adjustment for the $13.50 call
The Options Clearing Corporation (OCC) contract adjustment published information
Note that under “Strike Prices”, the strikes will be reduced in value by $0.65, the amount of the special 1-time cash dividend. This is because share value will decline by $0.65 on the ex-date due to this unusual event. There is no reduction in strike price for the regular quarterly dividend, as that one was anticipated and baked into the option pricing previously.
Will the call buyer exercise the option in order to capture the 2 dividends?
If the option buyer does exercise to capture the 2 dividends, the time value of $0.32 would be lost and shares would be purchased at a slightly higher price than current market value. Can it happen? … Yes. An inexperienced retail investor would have to serve an exercise notice to their broker and ultimately off to the OCC and back to the seller’s broker and then to the seller. Unlikely, but possible.
The better approach for the option buyer would be to sell the option (capturing the time-value of $0.32 per-share) and then purchase shares at market price to then capture both dividends. As rare as this is, if retaining the shares is critical to our trading strategy, there should be no option in place prior to the ex-date. The covered calls can be written on or after the ex-date.
Discussion
Our option contract parameters can change as a result of certain corporate events, including special 1-time cash dividends. Early exercise is rare but may occur as a result of investor error.