FRM Part I · FRM Exam Part I · Properties of Options
A stock trades at $80 and will pay a single dividend of $3 just before the ex-dividend date in 3 months. An American call on this stock has strike $60. Which statement about early exercise is correct?
Exercising an American call just before the ex-dividend date may be optimal. The holder of the option does not receive the dividend, and the stock price falls by about the dividend on the ex-date. For a deep in-the-money call, capturing the dividend can outweigh the interest and insurance value forgone.
- AExercise just before the ex-dividend date may be optimal, since the dividend lowers the stock price afterwards and holders of the option do not receive itCorrect
- BExercise is never optimal because the stock pays a dividend
- CExercise is optimal immediately after the ex-dividend date
- DExercise is optimal only at expiry regardless of the dividend size
Explanation
Option holders do not receive dividends, and the stock price drops by roughly the dividend on the ex-date, reducing the call's value. If the dividend benefit exceeds the interest on the strike plus the lost insurance value, exercising just before the ex-dividend date can be optimal. Here the call is deep in the money, so this is plausible. Exercise right after the ex-date forfeits the dividend.
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