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FRM Part I · FRM Exam Part I · Options Markets

Which statement about the effect of an expected dividend increase on American-style options on a stock, holding other factors constant, is correct?

Higher expected dividends reduce call values and increase put values. The stock price drops by roughly the dividend on the ex-dividend date, which hurts the call's payoff and helps the put's payoff.

  1. ACall values rise and put values fall
  2. BCall values fall and put values riseCorrect
  3. CBoth call and put values rise
  4. DBoth call and put values fall

Explanation

Dividends reduce the stock price on the ex-dividend date, which lowers the expected future stock price. This reduces call values and increases put values. Other inputs are unchanged so the direction follows directly.

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