Don't Get Stuck Paying the Dividend on Your Short Trade
If you're writing options on dividend-paying equities, you need to understand the risks of early assignment
Many trading strategies, such as covered-call or spread trading, involve options writing (selling), where the primary risks are market movement and volatility. But there's another risk if you happen to be writing options on dividend-paying equities like SPY ETFs: early assignment.
In a rush? Watch the video to learn about the risk of early assignment and the differences between American and European style options.
All options are either American or European style, which dictates when the option can be exercised or assigned. (It has nothing to do with geography.) All equity (single-stock) and ETF options are American style. American style options can be exercised or assigned at any point in time on or before expiration. SPY (ETF) options are American style, meaning the option owner may choose to exercise ahead of expiration. For example, this often occurs in advance of the quarterly ex-dividend date.
The ex-dividend date is the first trading day when a dividend-paying stock or ETF's price drops to reflect its next dividend payment. So, if an ETF pays a $0.25 dividend, the price may decline by that amount prior to trading on the ex-dividend date, barring other market factors.
If an option is in the money going into the ex-dividend date and the dividend exceeds the remaining time value of the option, the call owner likely has economic incentive to exercise their options early. This leaves the seller in the position of having to deliver the shares as well as the dividend.
Managing Early-Assignment Risk
An alternative is to try trading Mini-SPX Index options, which go by the ticker XSP℠. They also track the S&P 500® and they have the same notional size as SPY options. But Mini-SPX options are European style, which means they can only be exercised/assigned at expiration. European style options eliminate the uncertainty of early exercise, which many traders prefer. Also, index options do not pay a dividend. Mini Russell 2000 Index Options, trade under the ticker MRUT and are very similar, read more about them here.
Mini index options have a number of other advantages that traders appreciate, including cash settlement, which can help reduce risk of unexpected post-settlement market moves. Learn more about cash-settled versus share-settled options here.
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The information provided is for general education and information purposes only. No statement provided should be construed as a recommendation to buy or sell a security, future, financial instrument, investment fund, or other investment product (collectively, a “financial product”), or to provide investment advice.
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Options involve risk and are not suitable for all market participants. Prior to buying or selling an option, a person should review the Characteristics and Risks of Standardized Options (ODD) , which is required to be provided to all such persons. Copies of the ODD are available from your broker or from The Options Clearing Corporation, 125 S. Franklin Street, Suite 1200, Chicago, IL 60606.
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Not Buy and Hold Investment: VIX Index Products are not suitable to buy and hold because:
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- The VIX Index generally tends to revert to or near its long-term average, rather than increase or decrease over the long term.
Volatility: The VIX Index is subject to greater percentage swings in a short period of time than is typical for stocks or stock indices, including the S&P 500 Index.
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- The prices for the nearest expiration of a VIX Index Product generally tend to move in relationship with movements in the VIX Index. However, this relationship may be undercut, depending on, for example, the amount of time to expiration for the VIX Index Product and on supply and demand in the market for that product.
- Mini VIX futures contracts trade separately from regular-sized VIX futures, so the prices and quotations for Mini VIX futures and regular-sized VIX futures may differ because of, for example, possible differences in the liquidity of those markets.
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Exchange Traded Products ("ETPs")
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