Dividends impact option premiums. When a dividend is distributed, the cash holdings of a corporation is decreased and therefore, the company and its stock are worth less. The eligibility to receive the dividend depends on several factors including the size of the dividend. First, let’s define some terms:
Types of dividends
- Standard dividends: A distribution of a portion of a company’s earnings, which can be issued as cash or shares of stock. Most dividends are distributed on a quarterly basis
- Special dividends: A one-time distribution of corporate earnings, usually in the form of cash due to an exceptional amount of profit in a given time frame
Ex-dividend date standard rules
To capture a dividend, a shareholder must buy the shares prior to the ex-dividend date (aka the ex-date). Under normal circumstances, the ex-date is two days prior to the record date, which is the official date that the stock owner is, in fact, a shareholder of that company. Since it takes three days to settle a stock purchase, shares must be purchased three days before the record date. After that, two days before the record date, the stock goes ex-dividend and shares purchased from that point forward are no longer eligible to receive the dividend. The actual payment date is sometime after the record date. These standard rules apply to standard dividends and special one-time cash dividends, which distribute less than 25% of the value of one share.
Ex-dividend date special rules
When the special cash dividend distribution is an amount greater than 25% of the value of one share, the ex-date is set the day after the payment date. Therefore, if a stock is purchased after the record date but before the ex-date, the dividend is still captured. The ex-date always determines who receives the dividend, the stock buyer or seller.
Impact of special dividends on share value and strike prices: COSTCO example
In February, 2015 Costco (NASDAQ:COST) distributed a special one-time cash dividend of $5.00 per share. Since this amount was less than 25% of share value, standard ex-dividend date rules applied. The record date was February 9th (after a weekend) and the ex-date was February 5th. Option strike prices were reduced by $5.00 per share on the ex-date and share value also declined because of this distribution, as shown in the chart below:
Costco: Special dividend reducing share value
Summary
There are two types of dividends, standard and special one-time cash dividends. Special ex-dividend date rules apply when special dividends are greater than 25% of share value, and it is always the ex-date that determines who receives the dividend. For option sellers, share value and strike prices will decline by the dividend amount on the ex-date.
Market tone
US and International stocks rose broadly and with less volatility this week, as Greece accepted the new austerity plan laid out by its creditors and China reported better-than-expected second-quarter GDP growth (7% growth). Early reports of 2nd quarter US corporate earnings surprised to the upside. This week’s economic reports:
- US housing starts rose 9.8% in June to an annualized rate of 1.17 million units
- Permits for future home construction increased 7.4% to 1.34 million units, close to an eight-year high
- The National Association of Home Builders/Wells Fargo sentiment gauge held in July at the highest level since November 2005. Low mortgage rates and labor market strength are strengthening increased housing sector activity
- US consumer prices rose 0.3% in June, a fifth straight month of increases, as gasoline and other goods increased in price. For the 12 months through June, the Consumer Price Index rose 0.1%, its first positive stat in 2015
- Initial jobless claims fell 15,000 to 281,000 for the week ended 11 July, the 19th straight week below 300,000
- Continuing claims dropped significantly by 112,000 to 2.22 million for the week ended 4 July
For the week, the S&P 500 rose by 2.41% for a year-to-date return of 3.29%.
Summary
IBD: Confirmed uptrend
GMI: 6/6- Buy signal since market close of July 14, 2015
BCI: Moderately bullish favoring out-of-the-money strikes 2-to-1 and so far encouraged by early corporate earnings.
Wishing you the best in investing,