Option Valuation and Dividend Payments

11 Pages Posted: 21 Oct 2008

See all articles by Robert S. Harris

Robert S. Harris

University of Virginia - Darden School of Business

Robert M. Conroy

University of Virginia - Darden School of Business

Abstract

This note shows how dividend payments affect option values owing to the effects of dividend payments on share price and resulting investor behavior. In addition to discussing the underlying logic, the note shows how to value options for dividend-paying stocks by adapting the Black-Scholes option-pricing model. The note addresses issues of early exercise and the underlying incentives of investors who own call or put options.

Excerpt

UVA-F-1523

Option Valuation and Dividend Payments

When a company pays dividends, option valuation requires careful attention to the particulars of those payments. This note discusses how dividend payments affect option values and some approaches to handling those effects in valuation models. Valuation effects flow directly from the effects of dividend payments on share price and resulting investor behavior. First, let's consider some key features of dividend payments themselves.

Dividend Payments

Cash dividends are payments from the firm to shareholders. When a dividend payment is announced, the firm also provides information on two important events. The first is the holder-of-record date. The list of shareholders on that date receives the dividend. The other date is the payment date. The dividend will actually be paid on that date. The exchange on which a stock is traded also sets something known as the ex-date or ex-dividend date. The ex-date is the date on which purchasers of the stock do not receive the upcoming dividend. For the New York Stock Exchange (NYSE), the ex-date is set by Rule 235:

NYSE Rule 235. Ex-Dividend, Ex-Rights: Transactions in stocks (except those made for “cash”) shall be ex-dividend or ex-rights on the second business day preceding the record date fixed by the corporation or the date of the closing of transfer books. Should such record date or such closing of transfer books occur upon a day other than a business day, this Rule shall apply for the third preceding business day.

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Keywords: options, Black-Scholes option-pricing model, dividends, valuation

Suggested Citation

Harris, Robert S. and Conroy, Robert M., Option Valuation and Dividend Payments. Darden Case No. UVA-F-1523, Available at SSRN: https://ssrn.com/abstract=1279959

Robert S. Harris (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-4823 (Phone)
434-924-4859 (Fax)

HOME PAGE: http://www.darden.virginia.edu/faculty/harris.htm

Robert M. Conroy

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

HOME PAGE: http://www.darden.virginia.edu/faculty/conroy.htm

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