Question

29) Assume a company’s stock goes ex-dividend after the market closes on October 6. Compare the value of the options when the market closes on October 6 to the value of the options when the market opens on October 7. Assume all factors utilized in valuing the options (other than the dividend effect) are held constant. What will happen to the

value of the company’s options?

1. the value of both calls and puts will fall
2. the value of both calls and puts will not be affected
3. the value of puts will fall while the value of calls will rise
4. the value of puts will rise while the value of calls will fall

Answer 1

Answer: d. the value of puts will rise while the value of calls will fall

• Share price of stock falls after the stock goes ex-dividend by the amount of dividend payment. The fall in share price reflects that buyers post ex-dividend date (here October 6) are not entitled to receive dividend.
• Put option provides buyer a right to sell the stock on a predetermined price. As stock price decreases value of put option increases.
• Intrinsic value of put option = (Strike price – Stock price). As strike price remains unchanged and stock price fall, so puts rise.
• Call option provide buyer a right to buy the stock on predetermined price. As stock price decreases value of call option decreases.
• Intrinsic value of call option = (Stock price – Strike price). As strike price remains unchanged and stock price fall, so calls will fall.