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ACCA Strategic Professional · Advanced Financial Management · Application of option pricing theory in investment decisions

Which statement about the effect of an expected dividend payment before expiry on the value of European options on a share is correct, all else equal?

An expected dividend before expiry lowers the call value and raises the put value. Option holders do not receive the dividend, and the share price falls when it goes ex-dividend, reducing the likelihood of calls finishing in the money while favouring puts.

  1. AIt increases the value of the call and decreases the value of the put
  2. BIt decreases the value of the call and increases the value of the putCorrect
  3. CIt decreases the value of both the call and the put
  4. DIt has no effect because option holders do not receive dividends

Explanation

A dividend lowers the share price on the ex-dividend date, and option holders do not receive it. This reduces the expected share price at expiry, so calls lose value and puts gain value.

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