Ex-Dividend Arbitrage in Option Markets

Abstract

We examine the behavior of call options during the ex-dividend period of their underlying stocks. The evidence is inconsistent with the predictions of rational exercise policy; a significant fraction of the open interest remains unexercised. The potential profits to the option writers trigger a sophisticated trading scheme that enable short term traders to receive a significant fraction of the gains. The trading scheme inflates reported volume and distorts its traditional relations to liquidity. The dramatic increases in volume of trade on the last cum-dividend day are facilitated by limitations on transaction costs passed by the various option exchanges.

Keywords: Arbitrage, option market, Ex-dividend