Bryan Perry

Dividend Yields Can Impact Option Values

    Tweet This

Free Trading Guides

Another thing to keep in mind when you aim to capture option premiums and dividends from such entities as indices, Exchange-Traded Funds and Holding Company Depository Receipts -- known as 'HOLDRs' is that activity that takes place in any one of the companies that comprise part of the overall entity will impact those invested in the overall "basket" of stocks that each represents.

For instance, let's say ABC Company plans to distribute a special dividend to shareholders next week. Shareholders are entitled to a 12-cents-per-share dividend. But let's say ABC Company is part of an Exchange-Traded Fund that let investors play an entire segment. If you've bought options on the ETF, then any dividend-related price action that impacts ABC may also affect the overall price of the basket of stocks you're playing.

So, while options on ETFs and other vehicles through which you can play an industry (i.e., software, biotech, retail) in one transaction trade just like equity options, their values may also fluctuate on any given day because of activity in one or more of their components.

While investing in a market segment might be easier to do insofar as not choosing which company will flourish and instead choosing which industry will do well -- or not do well -- you may want to do a little extra homework on the individual components because if one company that has a particularly heavy weighting within the basket is having a good or bad day, this may tell you how your trade will perform.

There is actually a way for investors to enjoy dividends with their options, but it involves the more-advanced trading strategy of writing covered calls. The risk, however, is that if you sell a call against your long stock position at a higher strike price than its current market value -- and then the stock trades up through that price -- you might be "assigned" to provide your long shares to an individual who bought the call that you shorted.

So, in exchange for the premium you collected for the short call, you may sacrifice future dividends, as well as any additional upside the stock might have enjoyed.

For now, it's enough to know that ignoring the impact of dividends for an underlying stock can cause an option to seem undervalued by as much as 15%. So when you're looking for options that you want to buy, be sure to find out whether the underlying stock pays dividends and when those payments are set to arrive, and you can determine whether the option you want to buy is a bargain or whether it belongs on the bargain-basement shelf.