Question

Explain the effect of dividends on both call and put premiums. If you owned a put option that expired in 90 days, would you prefer to have a $1 dividend on the stock in 10 days or in 50 days. Explain your answer.

Answer 1

The below statements are made assuming all other things constant.

Effect of dividends on both call and put premiums:

Dividends effect the underlying stock price and hence effect the premiums of the Call and Put options. The stock is expected to fall by the amount of the dividend on the ex-dividend date and hence, with dividends, the premium of Call option is decreased and Put premium is increased.

Effect of dividends on both call and put exercise prices:

Dividends effect the underlying stock price and hence effect the premiums of the Call and Put options. The stock is expected to fall by the amount of the dividend on the ex-dividend date and hence, with dividends, Put options become more expensive and the Call options become cheaper.

If you owned a put option that expired in 90 days, would you prefer to have a $1 dividend on the stock in 10 days or in 50 days.

In case of Put options, the price of the put option is expected to go up by the value of the discounted value of the future dividend. The discounted value of $ 1 dividend on the stock in 10 days is slightly more than the value of $ 1 dividend on the stock in 50 days. Hence one would prefer to have a $ 1 dividend on the stock in 50 days .