Option Strategies – Profit-Making Techniques for Stock, Stock Index, and Commodity Options : [PDF Download]

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“If a stock pays dividends (and many do), the dividends affect the price of an option on that stock particularly at the time that the payment is made. The value of the underlying stock will rise each day, all other things being equal, until the day the dividend or interest is paid.

This is because the value of the stock is increased by the impending payment. For example, a stock with a $1 dividend payment is worth more one day before the ex-dividend day than 30 days before. (The ex-dividend day is the last day that you can own a stock and receive the dividend.)

The reason is that the total return of buying the stock is greater one day before ex-dividend day because you will have that $1 dividend. The day after the dividend payment is made, the price of the stock will drop approximately the same as the value of the payment. This affects the option as well.

The option price will drop following the payment, even though the option owner does not receive the payment. This also has the effect of reducing the value of options that pay high dividends relative to those that pay low or no dividends. The dividend also has the microscopic effect on options of having the dividend receiver earn interest on the dividend.”

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