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Ways to Exploit ex-Dividend Effects?

| | Posted in: Equity Options, Short Selling

A reader asked: “I am under the impression that stocks usually drop by the amount of the dividend on the ex-dividend day. Is this true…or more precisely, how true is this? If it is true, couldn’t one just short the stock on that day? If it is not true, could you just hold the stock for that day and reap the dividend? Also, could options be used to make some profits on this? Selling calls or buying puts?”

There is a fairly long-term stream of research (since about 1970) on the typical ex-dividend day price behavior of individual stocks. On average, it appears that stock price tends to drop a little less than dividend amount (at least in the U.S.), with the discrepancy perhaps driven by differential tax treatments for dividends and capital gains. Trading frictions would work against capturing any such discrepancy. The effect for funds may be different.

When you are short a stock, you have borrowed shares from some other party and generally must compensate that party for any dividends paid on the stock.

Options market makers take into account scheduled dividends in calculating the prices of put and call options. Their calculations may be imperfect, but any defects with respect to dividends are likely very difficult for investors to identify and exploit.

There is research on a related anomaly involving an apparent general reluctance by holders of call options to exercise these options just before ex-dividend, even when rationally advantageous to do so:

“Ex-Dividend Arbitrage in Option Markets”

“Failure to Exercise Call Options: An Anomaly and a Trading Game”

The net of this research appears to be that only very low-cost traders (such as market makers) can effectively exploit the anomaly.

You can find additional formal background research by searching SSRN for “ex-dividend” and [“ex-dividend” options]. There are also many related discussions on investor-oriented web sites.

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