I was reading Jeff Augen’s The Options Trader’s Workbook: A Problem-Solving Approach
(Amazon link) on dividend arbitrage. Basically, you are looking for mis-priced options. The puts could be mispriced because the market doesn’t expect the stock to drop by the amount of the dividend as it is supposed to.
Tomorrow, Abbott Labs (ABT) goes ex-dividend, paying $0.40; Mid America Apartment Communities (MAA) goes ex- paying $0.615; and Watsco Inc (WSO) goes ex- paying $0.48.
Nothing interesting in ABT or MAA, but WSO puzzled me. The stock was trading at $53.60 and the Oct 55 puts expiring Saturday, were 2.25 bid, 2.75 offered. One way to think about the value of the put is to add up its intrinsic value and the dollar amount of time decay to expiration. In this case, the intrinsic value of the put was 55 – 53.6 = 1.4. Theta is 0.041 per day, so with five days left, that is 0.205 in time decay “value”. Adding it up, we get 1.605 not 2.25.
So one could sell the put and sell stock to hedge. That way, at expiration, the in the money put is exercised and stock is put to me, flattening out my position.
Here is what the return graph looks like (click on the image to enlarge):
So if WSO stays below 55.88, this trade is a winner. Since I am short the stock, I have to pay the dividend which reduces the return. Instead of 2.25 – 1.4 = 0.85, the return is 0.85 – 0.48 = 0.37 minus transaction costs.
Note: This is equivalent to selling the Oct 55 call against cash and letting it expire, if worthless, at the end of the week.
We’ll see if this reasoning holds up.
You are selling stock and selling the put.
Why bother?
Just sell the call instead. It’s the equivalent play.
Question: Do you want to sell this naked call and collect 37 cents?
Regards,
Mark
Selling stock and puts? Why bother? Just sell the call – it’s the equivalent play.
Question: Do you want to sell the Oct 55 call naked – for 37 cents (less commissions)?
Regards,
Mark
I realized this only later. I was embedded in one way of thinking about the trade. It is always valuable to look at the equivalent transformed trade to really understand what is going on.