Special Dividends and Option Contract Adjustments
There are times when option contracts are adjusted for corporate events like stock splits or special dividends. In the case of a 2-1 stock split for example, the option contract strike price is adjusted in half and the number of contracts doubled.
There is no contract adjustment for ordinary dividends. Regular dividends that are paid on a quarterly basis are factored into the option’s price. When a stock goes ex-dividend the stock’s price is adjusted by the amount of the dividend. The call and put option’s price reflects the amount of the dividend.
Due to the ongoing fiscal cliff negotiations, many companies are opting to pay out special dividends this year before the anticipated increase in the dividend tax rate. Currently dividends get a special tax rate of 15%. That rate could go as high as 39.6% in 2013 depending on the outcome of the fiscal cliff negotiations. Campbell soup became the last major company to declare a special dividend. Over 100 companies with a market cap greater than $240 million have declared special dividends this year. The total value of all the dividends is almost $23 billion.
If you’re using a covered call or a collar strategy to collect dividends, remember that with these special dividends, the strike price will be adjusted downward to reflect the special dividend unlike the ordinary dividend.