Including Dividends in Option Valuation Before Expiry
Summary
The document clarifies how dividends enter Black–Scholes–Merton valuation when a stock has a scheduled ex-dividend date. The relevant dividends are those whose ex-dividend dates occur before the option expires: an option holder does not receive the dividend during that period, unlike a stockholder. Dividends scheduled after expiry do not reduce the option’s value for that contract merely because they are the stock’s current or usual yield.
The answer frames the adjustment around entitlement at expiry and notes a timing complication when expiry and the ex-dividend date coincide. The outcome can depend on when the stock goes ex-dividend and when the option expires, and some European-style contracts may have different exercise treatment on their final day. The explanation is conceptual; it does not specify a general adjustment formula or settle every contract-specific timing convention.
Key ideas
- Include announced dividends with ex-dividend dates before the option expires.
- A dividend after expiry does not affect the option through this dividend adjustment.
- The adjustment reflects dividend income a stockholder receives but an option holder does not.
- When expiry and the ex-dividend date coincide, contract and market timing details matter.
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Full text
# When to include dividends in option valuation # When to include dividends in option valuation When using the Black-Scholes-Merton method for option valuation which takes into account dividends, does the dividend only get included into the calculation of options whose lifetime straddles the dividend exdiv date? For example today is 16Nov2015. Lets say stock xyz has an upcoming exdiv date on 16Jan2016. If im valuing an option whose expiration is in either November or December, do I include January's dividend into that calculation because they expire before the exdiv date. Or do I only include options whose expiration is after the exdiv date? Or do I simply always include the stocks current dividend yield into the calculation,...regardless of whether the options expiration falls before or after the next exdiv? ## Answer by quis est ille (score 2, accepted) https://quant.stackexchange.com/a/21765 The dividend adjustment in the option formula represents compensation for dividend income that an ordinary stockholder will have entitlement to before expiry, but which you the option owner will not be entitled to. If at expiry you exercise into a stock that has not gone exdiv, then you are entitled to the dividend, and so should not include it in your calculation. But you should include any dividends that were announced and went exdiv before expiry, and which you will thus never receive. It is more complicated if expiry date is the same as exdiv date. From memory, it goes exdiv at a certain time of day. Typically options also have a specific time of expiry. Note also some european contracts go american on expiry day.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.