FRM Part I · FRM Exam Part I · Options Markets
A stock pays a $2 cash dividend, and a listed call option on it has a strike of $50 and covers 100 shares. Under standard exchange rules, how is the option contract treated for this dividend?
No adjustment is made. Listed options are normally protected against stock splits and stock dividends but not against ordinary cash dividends, so the strike stays at $50 and the contract stays at 100 shares, which can make early exercise of calls attractive.
- AThe strike price is reduced by $2 to $48
- BNo adjustment is made to the terms for the cash dividendCorrect
- CThe number of shares is increased to 104
- DThe option is exercised automatically before the ex-dividend date
Explanation
Exchange-traded options are generally not adjusted for cash dividends, which is why early exercise of calls just before ex-dividend dates can be optimal. Strike reductions or share-count changes apply to stock splits and stock dividends, not ordinary cash dividends. Options are also not exercised automatically early.
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