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Russell Rhoads
The Options Institute at CBOE

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Adjust for Special Dividends

While a regular dividend is expected and typically paid to the stockholder on a quarterly basis, a special cash dividend is an extraordinary dividend which is distributed unexpectedly. The significance of any dividend is the subsequent adjustment in the stock price. A stock's value should decrease by the amount of the dividend the day after the stock has gone ex-dividend. For example, if XYZ closed at 40.00 and paid a 0.50 dividend, then an opening that is based on no price change in XYZ would be 0.50 lower at 39.50 the following morning.

Let's say Company XYZ declares a special cash dividend of $1.00 per share. The ex-dividend date for the special dividend was June 15, which means the holders of record on this date received $1.00 per share. The stock price was also adjusted $1.00 lower for the opening on June 16. Finally, the option contracts also had their strike prices adjusted lower by 1.00. The table below shows the old and new contract specifications.

Long equity option contracts entitle the holder the right to buy or sell an underlying stock. They do not carry any right to the dividend paid to holders of the underlying stock. Because the value of the option contract is based on the stock price and the stock price is adjusted lower, the strike prices of all put and call contracts on that stock will also be adjusted lower. There are a few moving parts here, so an example using the XYZ special dividend follows to illustrate.

A long holder of 1 XYZ Jun 30 Call would have had their contract converted into 1 XYZ Jun 29 Call. A lower strike price allows the contract holder the right to buy the stock at a lower price. Lowering the strike price will result in no negative economic impact on the option holder, due to the result of the lower stock price which accompanied the special dividend. The stock price was adjusted $1.00 lower based on the special dividend paid to holders on June 15. Therefore, the strike price was lowered by the same amount as well.

Taking this a step further, let's say you bought 1 XYZ Jun 30 Call before the special dividend for a premium of 1.50 and held the contract through expiration on Saturday, June 18. As of the market open on June 16, you now hold 1 XYZ Jun 29 Call. This is a result of the contract adjustment associated with the special dividend. At expiration, XYZ stock closed at 35.50, and we exercised our right to buy 100 shares of XYZ at 29.00. The net result is a long position in XYZ of 100 shares with a cost of 30.50. This cost is determined by adding the option premium of 1.50 to the 29.00 exercise price of the call. Finally, we have an unrealized profit of 5.00 (not including commissions) after exercising our contract as the stock is trading 5.00 higher than our effective cost of the shares.

If there had been no special dividend paid, then you may have just held the Jun 30 Call through expiration. First, in our example, the stock would have been trading at 36.50 instead of 35.50, because the price did not adjust for the special dividend. We would have exercised our 30 strike call with the net result being long 100 shares of XYZ at an effective price of 31.50. Again, the unrealized profit is 5.00 (not including commissions) as the stock is trading at 36.50 and our effective cost was 5.00 lower. The net result in both cases is the same unrealized profit.

Option contract adjustments are not the easiest topic to master. Each case may be handled differently as dictated by the Options Clearing Corporation. If you have an option position and know a split or special dividend is on the horizon, check www.cboe.com/contractadjustments. On this page, you can find explanations for all pending adjustments as well as historical adjustments. Always remember, the adjustment may change the composition of the option contract you own, but economically there should be no real change based on the adjustment.

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