RFS Advance Access published online on May 21, 2009
Review of Financial Studies, doi:10.1093/rfs/hhp038
Ex-dividend Arbitrage in Option Markets
Wayne State University
Tel Aviv University and University of Utah
U.S. Securities and Exchange Commission
Send correspondence to Jia Hao, School of Business Administration, Wayne State University, Prentis Building Room 313, 5201 Cass Ave., Detroit, MI 48202; telephone: 313-577-5059; fax: 313-577-5486. E-mail: jia.hao{at}wayne.edu.
JEL Classification: G13, G14, G18
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Abstract |
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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.
We wish to thank Yakov Amihud, Peter Demarzo, David Dubofsky, Michael Gordy, Bjorn Jorgensen, Elizabeth King, Matt Spiegel, and participants of the finance seminar at the Indian School of Business, IDC, the Hebrew University, the University of New South Wales, Queensland University of Technology, the University of Utah, Tel Aviv University, the Securities and Exchange Commission, the University of Kansas, Skinance 2007, CICF 2008, and WFA 2008 for many helpful comments. Part of this research was undertaken while Kalay was visiting academic scholar at the Securities and Exchange Commission in 2004. The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the authors and do not necessarily reflect the views of the Commission or of the author's colleagues on the staff of the Commission. All errors and omissions are the sole responsibility of the authors.