How Higher Dividends Affect European Call Values
Summary
The document explains why an increase in a dividend expected before a European call’s expiration generally reduces the call’s value. A dividend payment transfers value from the company to shareholders, so the stock price is expected to fall by the additional payout when the dividend is paid. That lower expected stock price reduces the call’s prospective payoff, all else equal. The example describes a call and a dividend increase, but the option’s delta does not imply that its value rises by delta times the dividend change: the dividend adjustment affects the expected stock price in the opposite direction.
Timing matters. If the dividend date comes after expiration, the payment does not affect the option’s value through this mechanism. The discussion assumes the dividend increase is known before the payment and focuses on its direct effect on company value. A dividend decision can also signal information to the market, but the direction and size of any signaling effect are uncertain and are not analyzed quantitatively.
Key ideas
- A dividend paid before expiration lowers the expected stock price, all else equal.
- That expected price reduction generally lowers the value of a European call.
- An option’s delta does not mean a dividend increase raises its value by delta times the payout change.
- A dividend after expiration does not affect the option through the payment’s direct price adjustment.
- Market reactions to a dividend decision may reflect signals whose direction and size are uncertain.
Tags
Full text
# Do European call options increase in value when dividends are increased? # Do European call options increase in value when dividends are increased? Say you have a call option whose current value is $4.73$ and has a $\delta = .43$. Let's say dividend is increased by $.37$. I would expect the option to increase in value by ($.43*.37$) since the stock's price will go up by $.37$. Sheldon Natenburg in Option Volatility and Pricing Workbook chapter 7, question 6c. expects the value to go down by the amount calculated above. Why is that? ## Answer by Bob Jansen (score 3, accepted) https://quant.stackexchange.com/a/58452 In your example, I believe it's assumed that the exercise date is after the dividend date. If the dividend date is after the exercise date, nothing happens. The value would decrease, consider the following timeline: - $t=0$: You have a call option worth $4.73$ and a stock worth $S_0$ - $t=1$: The increase in dividend is announced but dividends are not paid out yet. - $t=1 + \varepsilon$: The price of the option changes. - $t=2$: The dividend is paid. - $t=3$: Expiration date. At $t=2$, the price of the stock would decrease by $.37$ more than was expected at $t=0$. This implies a downward adjustment of the option price at $t=3$ and one can expect that the price of the option from $t=1$ to $t=1+\varepsilon$ to decrease. It's less likely to end in the money and if it ends in the money the payoff would be lower, ceteris paribus. Dividend decisions don't change company value as a first order effect. A decision to change dividends might give a signal to the market which has an effect on the price but the size and sign of that signal are hard to determine in general. Dividends come from the assets of the company so a dividend decrease the company value by the amount that is paid out. Otherwise it would be free lunch.
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