Assignment Risk, Short Calls, And Ex-Dividend Dates

Updated: Dec 29th, 2016 | Vance Harwood
 

If you are short call options in a stock or an Exchange Traded Product (ETP) like SPY or IWM you need to be aware of ex-dividend dates.  If your calls are in the money, even barely, your options may be assigned right before the security goes ex-dividend—and then you may have a problem.

For example, let’s say you hold a credit call spread position: short calls with lower strikes and long calls at higher strike prices.   If your short calls are assigned the night before the underlying goes ex-dividend you will wake up to find yourself no longer with an option spread, but short the security and half of your option spread remaining.

First the good news:

  • Your overall risk profile hasn’t changed much, you still have the long calls protecting you if the underlying moves up
  • Your theoretical maximum profits on the position are higher if the underlying drops because your gains are no longer limited by the strike price of your short position
  • You’ve collected the entire time premium from your short call position—you’ll only be down the intrinsic value of the call, the amount it was in the money.

The bad news:

  • Since you were short the security when it went ex-dividend you now owe the dividend on the security.  That amount will be deducted from your account when the dividend is distributed.   Your potential worst case loss from your position has been increased by that amount.
  • Do you have the margin in your account to support the short position in the underlying?  If not you will shortly be getting a “courtesy” call from your broker suggesting that you add funds or liquidate your short position.  There will be a deadline.
  • If the security you just went short is “hard to borrow” you will be getting a call from your broker.  Your short position exists, but actual shares have to be borrowed to sustain it more than a couple of days. Extra fees may be involved, or if shares can’t be found to borrow you’ll have to cover the position.
  • Is your spread position in an IRA?  If so being short a security is a definite problem—not allowed by the IRS.  You must cover the short within a day or two—if not your broker will do it for you.  Luckily this will not result in a “free riding violation” because the cash generated by your short sale will be available in time to cover the purchase.

Call owners with in the money (ITM) options will typically exercise their options the evening before the ex-dividend date.  Holding the calls through the ex-dividend would cost them money because the underlying security usually drops in value when it goes ex-dividend.  At market open the drop in the securities’ price will usually roughly match the dividend amount.

In addition to assignment risk, the other thing to watch with ex-dividend dates is distortion in the implied volatility (IV) of options.  For example, the IV of deep ITM calls will be distorted because the market will not give you a profitable low risk trade (e.g., a covered call with deep ITM calls virtually certain to be assigned). You can create this position, but the premium from selling the calls will be non-existent, and therefore only risk and no profit.

Notice the implied volatility of zero on the bid side of the SPY ITM options a few days before the security goes ex-dividend:

SPY2-options

At the money (ATM) calls will also have reduced IVs.  Normally these won’t be assigned because they will have premiums higher than the dividend payout.  On the ex-dividend date you’ll see their IV’s jump up—just enough such that the call prices don’t move despite any drop in the underlying.  No easy money here.

If you find yourself the day before ex-dividend with ITM short calls there are a couple things you can do:

  • Sit tight and take the risk that the options be assigned—not all ITM calls will be exercised.  The deeper they are in the money, the higher the likelihood they will be assigned.
  • Roll your short options up to a higher strike price.  This should be done late in the day when it is unlikely that the underlying will move significantly before market close
  • Close out your entire position

One of the advantages of options on indexes like SPX (S&P 500) and RUT (Russell 2000) is that they don’t pay dividends—hence no worries about ex-dividend dates.

For special dividends option strike prices are often adjusted to protect option holders from unforeseen corporate actions.  For more see Profiting from Special Dividends.

For more on ex-dividend dates and options—a good article from Schwab.

It’s possible to use options to lower risks while collecting dividends, but it’s not a slam dunk.  For more information see Dividend Capture With Covered Calls.



Top 11 questions about dividends

Updated: Dec 29th, 2016 | Vance Harwood
 

Based on searches that lead people to Six Figure Investing, these are the top 11 questions people ask about dividends:

  1. When is XYZ’s ex-dividend date?   This information can be hard  to find.  Some companies provide the entire year’s dates on their webside (e.g., iShares),  others like Vanguard only reveal the information a few days before the ex-dividend occurs.  I have summarized / estimated ex-dividend dates for many of the popular ETFs here.

     

  2. When is XYZ’s distribution or pay date?  Same as question #1, this information can be hard to find.  I summarize pay dates along with ex-dividend dates for many ETFs here.

     

  3. When do I have to buy a security in order to receive the dividend?   The day before it goes ex-dividend or earlier.

     

  4. When can I sell a security and still receive the dividend?  On the ex-dividend date or later.  You can safely ignore the record date.  See here for a detailed explanation of how this works.

     

  5. What happens to a security’s price when it goes ex-dividend?  It will typically drop by the amount of the dividend—assuming the market is opening flat.   If the market is strongly up or down at opening the price will be influenced by this.

     

  6. What if I’m short the security on its ex-dividend date?  You owe the dividend.  It will be subtracted from your brokerage account on the distribution date.  You borrowed the stock, you are responsible for paying the owner of the security the dividend.  If you short the stock on the ex-dividend date or later (e.g., record date) you don’t owe the dividend.

     

  7. Do I get a dividend if I’m long call or put options on a security?   No, with an option you don’t actually own the security, you only have the right to buy or sell it, so you don’t get a dividend.  However, the prices of options are influenced by dividends, for example the bid price on deep in the money calls will decrease to compensate for an upcoming dividend.  If the dividend is a special dividend, not regularly scheduled, then your options will likely be adjusted, either with a revised strike price or a cash payout (neither to your benefit).  For more on option adjustments see this post.  For news on specific adjustments visit the Options Clearing Corporation Website.

     

  8. What happens if I’m short put or call options on a security when it goes ex-dividend?  If you don’t own any of the underlying security, then nothing direct happens.  Again the option prices are influenced by the security’s dividend, but there is no direct dividend received, or owed. If the premium on your short call is less than the dividend amount your calls may be exercised. If the dividend is a special dividend, not regularly scheduled, then your options will likely be adjusted, either with a revised strike price or a cash payout (neither to your benefit).  For more on option adjustments see this post.  For news on specific adjustments visit the Options Clearing Corporation Website.

     

  9. What if I have a covered call position with a security when it goes ex-dividend?  It depends on how much premium is present on the option price when the security goes ex-dividend.

    • If your calls are deep in the money, with premiums significantly less than the dividend amount, then your options will probably be assigned—and you will wake up on ex-dividend day with your position converted to cash—minus your security and your short options.  No dividend for you.
    • If your options are out of the money by more than the dividend amount nothing will happen to your calls and you will collect the dividend.
    • If your calls are between these two limits then it depends on the prices at the end of the day before the ex-dividend date.  My experience is that if the premium of your calls is 50% or less than the dividend amount, your calls will probably will assigned.

     

  10. Are there any dividend capture schemes that  isolate you from market risk?   The short answer for retail customers is no.  Wall Street excels at  preventing anyone from getting a free lunch.   You can use a covered call position to move away from the zero-sum situation on ex-dividend day of having a dividend, plus a security that has just dropped by the value of the dividend, but you are still exposed to significant market risk.  See this post for more on dividend capture schemes.

     

  11. What happens with a special dividend ?   The stock price will behave the same, dropping by approximately the dividend amount on the ex-dividend date.  Adjustments to the option’s strike prices will be made to existing positions if the special dividend amount  is more than $0.125 per share.  This adjustment process prevents options traders from experiencing big losses or windfalls when a special dividend is announced.  The Options Clearing Corporation newstream gives specifics on upcoming options adjustments. For more about special dividends see “Profiting From Special Dividends

     



Overview of dividend capture strategies

Updated: Dec 7th, 2011 | Vance Harwood
 

I have written several posts on dividend capture strategies.

My favored, although far from perfect strategy:

Dividend capture with covered calls

Some approaches I don’t recommend:

SPY dividend capture ideas that don’t work

Dividend capture—three approaches to skip

Additional background and tools, and an example:

Dividend capture overview

Covered calls–are you ready?

Combo orders–maximizing profits on covered calls

DIA dividend capture: creating the position

DIA dividend capture: position close out

More questions about dividends?  See Top 10 questions about dividends.



Saving money with combination orders

Updated: Jan 21st, 2013 | Vance Harwood
 
If you ever plan to trade more than straight long options you should learn to use combination orders, specifically debit and credit orders.
.
A combo order allows you to execute multiple trades simultaneously at a single integrated not-to-exceed price.  Some examples:
  • Creating a simple covered call position, buying the underling equity and selling-to-open calls
  • Creating a call bear option spread, selling the lower strike call, and buying the higher strike price.
  • Closing out a covered call position.
Combo orders can save you money by:
  • Reducing trading costs—typically commissions are reduced compared to executing the trades independently
  • Beating the bid/ask spread.
  • Eliminating the risk that the market will move against while you are in the middle of creating a two part position
  • Allowing you to explore the best price available on a multiple position sale.
  • Circumventing the $0.05 minimum increments on some option prices.
Combo orders require that you specify whether you want a debit  or a credit order.  Debit orders (sometimes abbreviated “Dr”) require you to put up cash to open the position, for example buying stock, or just going long on puts or calls.  Credit orders (sometimes abbreviated “Cr”) on the other hand deliver cash to you as a result of your trade.  Example credit transactions include closing out a covered call, selling stock short, or a bear option spread.
.
My mnemonic for keeping this straight:
  • Debit—I go into debt
  • Credit—I get the credit..

Figuring out the order price is the next challenge.   Your broker’s software might suggest a value—but you will probably leave at least a little money on the table if you use this number.  It’s like ordering your combo meal  à la carte rather than buying the “meal deal”.   My goal is to set a price that doesn’t fill immediately, but rather takes several minutes to execute.   When I see a delay I’m pretty sure I’ve gotten close to the best deal available.

I have found that splitting the bid / asked prices is a good starting point for combo orders. If that price doesn’t fill in a reasonable time you can always sweeten the offer.   So for example if I want to create a covered call position with Apple:.

Buy Apple stock    bid 516.01, ask 516.03   (split bid/ask price is 516.02)
Sell-to-open Apple S510 call   bid 17.30, ask 17.60  (split bid/ask price is 17.45)

If your broker’s software suggests a value for this order it would be the ask price on the Apple (516.03) minus the bid on the call (17.30) — for a net debit order of 498.73.

My initial limit price would be 516.02 minus 17.45  which is 498.57

If you get a fill at this lower offer you have saved $0.16 per share.    If your order doesn’t fill after a reasonable amount of time, either the market has moved against you, or your price isn’t sweet enough. Fidelity’s and Schwab’s software will generally allow you to change your price without cancelling your order.  If not —you’ll need to cancel and re-submit to change the price.  Remember on a debit order lower is better for you and on a credit order higher is better.

Partial fills can happen anytime you use a limit style order.   If you are ordering more than unit quantities (e.g., 1 call / 100 shares of stock, or single long/short option pairs) in a combo order you may see only a part get filled.  For example if I want to buy 300 shares of USO and sell-to-open 3 calls the exchange might execute only one third or two thirds of your order.

Generally partial fills are a good thing because it suggests you are right on the edge of what the market makers are willing to do.  Your commission costs are unchanged regardless of how many chunks your order gets divided into during the course of the day.   However if the market closes, or the market moves against you before your order completely fills then you will have to pay another commission if you want to complete your order.  You can prevent partial fills by selecting  “All”  in the “All Or None” (AON) order conditions, but you may need to sweeten your offer in order to get a fill.  I generally put my combo orders in during the morning, and I rarely have a problem.  Either the market won’t bite at all, or if I get some partial fills the order generally completes.

A few other points about combination orders:

  • Orders that mix both stocks/ETFs and options are not automatically handled and generally don’t provide fast execution.  Actual humans have to get involved with these trades, so expect execution in minutes, not seconds after you submit your order.
  • I have seen combo orders go stale  Even though they should have executed they don’t—maybe the brokers lose their sticky notes…   Cancelling and reentering the order will usually trigger execution.
  • You may see a “market” option in addition to the limit option with combo orders.  Avoid these.  Execution may be slow and you have no guarantee of what price your order will fill at..
If spreads are tight and time is of the essence I’ll execute sequential orders rather than take the time to setup a combo order.  I’ll use market orders with very liquid, low spread stocks, ETFs, and options if I’m in a big hurry, but generally I use limit orders with everything.
.
If you’re cheap and not in a hurry, or if the market is moving fast and you’re trying to create spread-beating, multi-sided positions (e.g., for dividend capture) then combo orders are the way to go.


Dividend capture by buying SPY and shorting IVV?

Updated: Mar 14th, 2013 | Vance Harwood
 

If your devious dividend capture plan involves you hedging against SPY’s price movements by selling IVV short until after SPY goes ex-dividend you can forget about it. The IVV (Barclays Global) price doesn’t drop by SPY’s dividend amount on SPY’s ex-dividend date. It continues to track the S&P 500 until it goes ex-dividend a few days later. Your master plan will net out with you down by at least your commission costs.

For  IVV and SPY ex-dividend and distribution dates and lots of others  see here.

If you are interested of an overview of dividend strategies—some of which actually work, see this post.

Thanks to Jeff in the comments below for pointing out to me that IVV management doesn’t have to do anything in order for this to play out this way.

IVV vs SPY (June 2010 ex-dividends), click to enlarge