# Understanding How Dividends Affect Option Prices

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Dividend payments for a company have an influence on how options for that stock are valued. On the ex-dividend date (the first trading day when an impending dividend payment is not reflected in a stock’s price), stocks often decrease by the amount of the dividend payment. This shift has an influence on option price. Because the underlying stock’s price is likely to decline in the days running up to the ex-dividend date, call options are less costly.

Simultaneously, the price of put options rises owing to the same projected decline. Investors must grasp the mathematics of option pricing in order to make educated trading choices.

### Key Takeaways

• The payment of dividends affects options listed on equities since holders of the underlying shares get dividends but call and put holders do not.
• When the underlying stock goes ex-dividend, call options lose value and put options gain as the stock price reflects the dividend to be paid.
• Deep-in-the-money American-style calls may be exercised prior to the ex-dividend date in order to collect the dividend payment payable to the underlying shares.
• The Black-Scholes model is unsuitable for evaluating American options on dividend-paying equities.

### Stock Price Drop on Ex-dividend Date

The record date is the company’s cut-off date for receiving a dividend. To be eligible for the dividend, an investor must hold the shares by that date. Other regulations, however, apply.

If an investor purchases the shares on the record date, the dividend is not paid. This is because a stock transaction takes two days to settle, which is known as T+2. It takes time for the exchange to process the papers necessary to complete the transaction. As a result, the investor must hold the shares prior to the ex-dividend date.

As a result, the ex-dividend date is critical. All else being equal, the stock price should fall by the amount of the dividend on the ex-dividend date. Because the corporation is forfeiting that money, its value has decreased because the money will soon be in the hands of someone else. Everything else does not stay constant in the actual world. While the stock should theoretically decline by the amount of the dividend, it might increase or fall considerably more since various variables, not only the dividend, influence the price.