Bryan Perry

Dividend Yields Can Impact Option Values

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While options trading offers tremendous profit opportunities with more flexibility and less capital than stock investing, generally if you don't own the underlying stock, then you won't reap the dividend payments.

However, this doesn't mean you should overlook corporations' dividend payouts. Dividends are one of the most important variables that determine an option's premium, along with volatility, time, interest rates and the price of the underlying stock. Therefore, it's important to note that cash dividends typically impact the underlying stock price.

For example, if company XYZ announces a $1 dividend, the stock price for XYZ is expected to drop by $1 on the ex-dividend date. (If you buy a dividend-yielding stock one day before the ex-dividend date, you will still get the dividend. But if you purchase it on the ex-dividend date, you will not get the dividend. The converse is true for selling a stock.) The important thing to remember is that high cash dividends generally mean lower call premiums and higher put premiums.

The timing for dividend-related price fluctuations is different for the underlying stock price and options premiums. While the underlying stock price usually corrects just once on the ex-dividend date, options prices (or premiums) will swing in the weeks and even months before the payout is executed. It doesn't hurt to understand how dividends might impact your projected returns.