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DIVIDENDS AND COVERED CALL WRITING

EXERCISING A CALL OPTION FOR THE DIVIDEND

QUESTION

"In covered call writing, the ex-dividend date can be more important than the expiration date. If the call is exercised, there is no dividend for the covered call writer. It is possible to have a negative return."

 REPLY
When the call owner exercises and collects the dividend, you should NEVER have a negative return. If you discover that you have no profit (or very little profit), then you did not collect a sufficient premium when writing the call option. In other words, you made a serious error.
FOR EXAMPLE:

Stock is $52 per share and pays a $0.50 dividend.
Ex-dividend date comes before the call option -- the one that you sold -- expires.
Let's assume that

·         You write a call (any expiration month) with a $50 strike price

·         You are assigned an exercise notice and sell your shares at $50

·         You do not collect the dividend

Then - you still earn a profit anytime that you sell the call and collect a premium that is more than $2.00 (the option's intrinsic value) -- as long as you are eventually assigned an exercise notice.
It is a very big mistake to sell any option when there is no profit potential. Never depend on collecting the dividend when the option is significantly in the money.  Sure, you may collect the dividend, but do not count on doing so. The option sale -- all by itself -- must be enough to guarantee a profit if you are ever assigned an exercise notice. If the stock price declines and the option expires worthless, then no profit is guaranteed because there is risk of losing money with any strategy that involves stock ownership because it may undergo a large price decline.
OPTION PREMIUM FOR THE COVERED CALL WRITER
The option premium must be at least the sum of the following:

·         The intrinsic value of the option

·         Enough to cover commissions -- both for entering the trade and exiting the trade. This may be another $0.25

·         Enough profit to make the trade worthwhile. I don't know how much this number should be for you, but for me it would be at least another $0.50 (and this depends on how far away expiration day is, the risk of owning the specific stock, and the strike price).

·         Total: 2.00 + 0.25 + 0.50 = $2.75.  I would need $2.75 to $3.00 before I would sell this option as a covered call. If you collect that much, then YOU DO NOT NEED THE DIVIDEND TO EARN WITH A PROFIT.

The ex-dividend date and expiration date are both important, but it is not a good idea to believe that the ex-dividend date is more important for option traders:

·         Many stocks pay zero dividends.

·         Most option strategies have nothing to do with dividends.

·         Expiration date establishes a time limit for the specific option trade, regardless of strategy. 

Being assigned an exercise notice and failing to collect the dividend, is not always something negative for the covered call writer.  How is that possible? 

·         When writing the option, always be prepared to be assigned prior to ex-dividend date. Then it will never be an unpleasant surprise.

·         Once you are assigned, there is no longer any downside risk. In fact you have earned the maximum possible profit for the trade and you no trader should expect to do better than that.

In your situation, you are not satisfied with that profit (or lack of profit). Thus, you did not sell the correct (for you) call and/or you did not collect a sufficient premium.
When the call owner exercises and collects the dividend, you should NEVER have a negative return.
If you discover that you have no profit (or very little profit), then you did not collect enough premium when writing the call option.

For example:

Stock is $52 per share and pays a $0.50 dividend.
Ex-dividend date comes before the option expires.
Let's assume that

·         You write a call (any expiration month) with a $50 strike price

·         You are assigned an exercise notice and sell your shares at $50

·         You do not collect the dividend

Then - you have a profit anytime that you sold the call and collected a premium that is

·         More than $2.00. With the stock trading at $52 per share, it would be very wrong to sell the option when there is no profit potential. You should not depend on collecting the dividend to earn a profit. The option trade -- by itself -- must be enough to generate a profit because you are taking risk by owning the position.

·         The option must be priced at the sum of the following:

o    The $2.00 intrinsic value

o    Enough to cover commissions -- both for entering the trade and exiting the trade. This may be another $0.25

o    Enough profit to make the trade worthwhile. I don't know how much this number should be for you, but for me it would be at least another $0.50 (and this depends on how far away expiration day is).

o    Total: 2.00 + 0.25 + 0.50 = $2.75.  I would need $2.75 to $3.00 before I would sell this option. If you collect that much, then YOU DO NOT NEED THE DIVIDEND TO COME OUT WITH A PROFIT.

The ex-dividend date and expiration date are both important. But

·         Many stocks pay zero dividends.

·         Most option strategies have nothing to do with dividends.

·         It is just wrong to suggest that the ex-dividend date is more important that the expiration date.