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Ex-dividend Arbitrage in Option Markets

Ex-dividend Arbitrage in Option Markets We examine the behavior of call options surrounding the underlying stock's ex-dividend date. The evidence is inconsistent with the predictions of a rational exercise policy; a significant fraction of the open interest remains unexercised, resulting in a windfall gain to option writers. This triggers a sophisticated trading scheme that enables short-term traders to receive a significant fraction of the gains. The trading scheme inflates reported volume and distorts its traditional relations to liquidity. The dramatic increases in the volume of trade on the last cum-dividend day are facilitated by limitations on transaction costs passed by the various option exchanges. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Financial Studies Oxford University Press

Ex-dividend Arbitrage in Option Markets

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Publisher
Oxford University Press
Copyright
© The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org.
Subject
Article
ISSN
0893-9454
eISSN
1465-7368
DOI
10.1093/rfs/hhp038
Publisher site
See Article on Publisher Site

Abstract

We examine the behavior of call options surrounding the underlying stock's ex-dividend date. The evidence is inconsistent with the predictions of a rational exercise policy; a significant fraction of the open interest remains unexercised, resulting in a windfall gain to option writers. This triggers a sophisticated trading scheme that enables short-term traders to receive a significant fraction of the gains. The trading scheme inflates reported volume and distorts its traditional relations to liquidity. The dramatic increases in the volume of trade on the last cum-dividend day are facilitated by limitations on transaction costs passed by the various option exchanges.

Journal

The Review of Financial Studies – Oxford University Press

Published: Jan 1, 2010

Keywords: JEL Classification G13 G14 G18

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