It is important to remember if you are selling options (covered or uncovered), the risk of being assigned is always present. The likelihood of your option being assigned early increases when the underlying security announces an ex-dividend date.
When a dividend for a stock is declared an investor must own the stock before the ex-dividend date to receive the payment. Dividend risk may occur in this situation because short calls are exposed to early assignment. Investors who are looking to receive the dividend payment may exercise a long call option early so that they are eligible to collect the dividend payment. This can occur whether the contract is in the money or not. The investor who wrote (sold) the call option would be responsible to deliver the shares if the option is exercised against them which may put them in a short position. If a short position is held through the ex-dividend date, then the investor would be responsible for paying the dividend on the payable date. This risk exposure can be avoided if an investor closes out the short option the day before the ex-date to prevent them from being assigned early.
Here are a few helpful tips that may help avoid Dividend Risk Exposure when trading options.
- Do your research ahead of time. Know if the stock or ETF pays a dividend, and if it does what date will it start trading ex-dividend?
- Avoid selling options on dividend-paying stocks or ETFs when your trade includes ex-dividend
- Think about investing in European-style options: American-style options can be assigned at any time before the option expires, while European-style options can only be exercised on the day of expiration.
Example:
An investor is Short 1 ABC March 5th $130 Call and Long 1 ABC March 5th $135 Call.
- The Ex-dividend date is 3/3/21
- The Dividend Payment $0.50
In the scenario above the investor is at risk of being assigned early on 3/2/21 which is the day before the ex-date. If the contract is exercised, in addition to the strategy being broken by early assignment the investor could be short 100 shares of ABC on 3/3/21 (ex-dividend date) which means the trader would be responsible to pay the dividend on the payable date. The cost for the trader in this situation would be $50 (100 shares x $0.50). If the trader wanted to try and avoid this situation from occurring the trader could buy back the ABC $130 Call before the end of the trading day on 3/2/21 to flatten out his position and avoid being assigned early, or they could close out the entire strategy.
*Not all dividends are announced with fore-warning – some securities may announce the dividend on the day of the ex-date.
Option trading entails significant risk and is not appropriate for all investors. Option investors can rapidly lose the value of their investment in a short period of time and incur permanent loss by expiration date. Additionally, investors can lose more than their initial investment. You need to complete an options trading application and get approval on eligible accounts. Please read the Characteristics and Risks of Standardized Optionsand Option Spread Risk Disclosure before trading options.