Question

a company declares a 15% stock dividend.explain how the terms change for 100 call options with a strike price $110.

Answer 1

Stock dividends affect option prices through their effect on the underlying stock price. The underlying stock price is expected to drop by the amount of dividend declared. So, if dividend declared is 15%, the stock price will fall by 15%. Thus, if a call option with strike price of $110 is trading 'in the money', the declaration of dividend would reduce the intrinsic value of call option. As the intrinsic value of the call option reduces, the call option starts moving towards 'at the money' and eventually 'out of the money' options and it's premium falls accordingly. Thus higher stock dividend implies lower call premium.