Limits of Deep In-the-Money American Options for Dividend Estimation
Summary
The document concerns estimating discrete dividends from American option prices, using paired call and put implied volatilities around the forward as a proposed calibration signal. The question describes refining dividend estimates by expiry and adjusting assumed dividend amounts until call and put implied volatilities align. It reports that estimates varied substantially across days, but the document does not provide a tested alternative procedure or quantitative analysis of that instability.
The answer cautions against calibrating with deep in-the-money American options. Such options may be in the exercise region, where their value is driven by immediate exercise and offers little information about volatility or future dividends. Their poor liquidity and wide bid-ask spreads also make midpoint prices unreliable. The discussion is a focused warning about instrument selection and price quality; it does not resolve the broader calibration problem or establish how accurate the proposed near-forward approach is.
Key ideas
- Deep in-the-money American options may be exercised immediately.
- When immediate exercise dominates, option value reveals little about volatility or future dividends.
- Deep in-the-money contracts can be illiquid and have wide bid-ask spreads.
- No alternative dividend estimation method or accuracy study is provided.
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# Extracting implied dividends from American options # Extracting implied dividends from American options I am using end of day options data and want to extract discrete dividend information contained in the option prices. I am doing this for ETFs like SPY where I know the dividend schedule. These are the steps I am doing: - Create a "seed" div dictionary which has known div dates but approx. div values - Let's say the 1st and 2nd div dates are 19-Mar-21 and 18-Jun-21. Find all options that expire >= 19-Mar and < 18-Jun. I get 4 expiries: 31-Mar, 16-Apr, 21-May, 18-Jun. - For each expiry, I find the strike closest to the forward by finding min(callprice-putprice). I get the call and put options at this strike. - I then minimise for Call implied vol - Put implied vol for a range of divs (0.5initialestimate to 1.5initialestimate) using the brentq algo to get the "optimal" multiplier. - I average the multipliers I get for each expiry. This is the multiplier to be applied to the initial div estimate for first dividend date to get a final div estimate. - I repeat this process to refine div estimates for all div dates. I expected this process to yield results that were v tight. But doing this across several days yields a very wide range of estimates (Eg. For SPY, I am seeing estimate for Mar-21 div varying from 0.75 to 1.75 when actual div is likely to centre around 1.4) Appreciate any thoughts/ inputs into this, including any alternative approaches I could try. I did find a relevant thread here: Implied Dividend from American Options (in practice) but didn't fully understand the implementation. ## Answer by Radoslav Komitov (score 1) https://quant.stackexchange.com/a/82494 I should note that using deep in-the-money American options to calibrate to forward (as LocalVolatility had suggested) is not a good idea. A deep in-the-money American option often can be outside the continuation region, so it may be optimal to exercise it immediately and its value in that case will be +-(S-K). This value does not provide information on the volatility or the future dividends. Moreover, deep in-the-money American options are very illiquid, meaning high bid-ask spreads and inaccurate mid prices.
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