Any trader that has traded for a long enough period of time has most likely taken assignment on a dividend paying stock. This can be an eye-opening experience the first time you log into your account, only to find that you’re short 500 shares of CSCO. Thankfully, the risk of assignment associated with dividend paying stocks can be virtually eliminated if you know what to look for.
It is important to remember that most options are not exercised, but the few that are can all be traced back to the lack of any time value remaining in the option’s premium. In the case of a dividend paying stock, the decision becomes simple for the long call holder. If the time value in the option exceeds the upcoming dividend, then he should close the position with an equal and offsetting trade to capture that dividend. If the dividend exceeds the time value, then he should exercise the option, take the stock, and collect the dividend.
However, the impact of dividends on put-call parity can make looking solely at the time value remaining in the call option a bit misleading. Therefore, you should also examine the corresponding put option that shares the same strike as your call option. This is because a synthetic long stock position can also be created by keeping your long call and simply selling the same strike put. As a result, if the premium on the put option exceeds the dividend amount, then the long call holder would be better served creating this synthetic long stock position (rather than exercising and collecting the dividend). Conversely, it is the short call options that are ITM, where the corresponding put options are selling for less than the dividend amount, that are in danger of being assigned. This is because it is more advantageous for the long side to exercise and collect the dividend (rather than creating a synthetic long stock position).
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.