The Fallacy of Fully Dividend-Protected Stock Options and Convertible Bonds

Paul Zimmermann
Additional contact information
Paul Zimmermann: UP1 - Université Paris 1 Panthéon-Sorbonne, PRISM Sorbonne - Pôle de recherche interdisciplinaire en sciences du management - UP1 - Université Paris 1 Panthéon-Sorbonne

Post-Print from HAL

Abstract: Altering the terms of a call option to fully protect its value when the underlying stock goes ex-dividend turns out to be trickier than one might think, and the same problem applies to protecting a convertible bond when a stock dividend is paid. Simply lowering the strike price by the same proportion that the stock price falls reduces (S – X) by the same percentage, so to maintain the option's intrinsic value in dollars, the number of options must also be increased. This re-striking method equalizes the option's exercise value before and after the dividend, but the volatility of the underlying still changes. Zimmermann proposes a new correction method that preserves option value when dividends are paid. The difference between valuation under the new method and under the re-striking method is not insignificant, amounting to several points of implied volatility for a holding period of three to five years.

Keywords: Options; quantitative methods (search for similar items in EconPapers)
Date: 2016-02-28
References: Add references at CitEc
Citations:

Published in Journal of Derivatives, 2016, 23 (3), pp.61-72. ⟨10.3905/jod.2016.23.3.061⟩

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-03970698

DOI: 10.3905/jod.2016.23.3.061

Access Statistics for this paper

More papers in Post-Print from HAL
Bibliographic data for series maintained by CCSD ().