Top 10 Option Trading Tips

Option Trading Tip #9

My top 10 call and put option trading tips that I have learned, and that you MUST know before you start trading calls and puts.

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Trading Options Tip #9:

Dividends can have a significant impact on option prices, so know when your stock goes ex-dividend.

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If a stock goes ex-dividend on May 4, for example, then that means May 4 is the first day it trades without a dividend. So, if want to get the dividend you will have to own the stock by the close on the day before the ex-dividend date, May 3. Everyone who owns the stock at the market close on May 3 will receive the dividend, even if they sell the stock at the open on May 4.

This can affect option prices because normally stock prices are automatically adjusted down by the amount of the dividend paid on the morning of the ex-dividend date. So, if a stock was $10 at the close on May 3, and paid a $1 dividend with ex-dividend date of May 4, then the stock should open at $9 on the morning of May 3 (i.e. it's price has been reduced by the amount of the dividend just paid).

For small dividends (small as a % of the stock price) you probably won't even notice because the amount of the dividend paid is lost in the normal up and down of the stock movement. But when dividends are 5% of the underlying stock price (or more) you will definitely notice. A $100 stock that pays a $5 dividend will open at $95 on the morning after the dividend has been paid.

And that will affect option prices! Your 95-strike call option that had been 5 points in the money on the day before the ex-dividend date is no longer in-the-money on the morning of the ex-dividend date... it's now at-the-money! Likewise, your at-the-money put option before the ex-div date will be in-the-money the next morning by the amount of the dividend paid.