Asked by Bradley Chappelle on Apr 26, 2024
Verified
An American-style call option with six months to maturity has a strike price of $42. The underlying stock now sells for $50. The call premium is $14. If the company unexpectedly announces it will pay its first-ever dividend four months from today, you would expect that
A) the call price would increase.
B) the call price would decrease.
C) the call price would not change.
D) the put price would decrease.
E) the put price would not change.
Call Premium
The additional amount above the bond's face value that the issuer must pay to redeem it before maturity.
Unexpectedly Announces
Refers to unforeseen news or disclosures by a company that can significantly impact its stock price and investor perceptions.
Dividend
A dividend is a payment made by a corporation to its shareholders, usually in the form of cash or stock, from its profits or reserves.
- Elucidate the effect of dividend distributions on the pricing of options.
Verified Answer
JW
Jonah WaldenMay 02, 2024
Final Answer :
B
Explanation :
DWhen a company announces it will pay dividends, the stock price typically decreases by the amount of the dividend on the ex-dividend date, making a call option less valuable (hence, the call price would decrease). Conversely, this scenario makes put options more valuable, as the decrease in stock price can benefit the put option holder (hence, the put price would decrease is incorrect, it should actually increase, but since that option is not provided, D is the closest relevant choice given the options).
Learning Objectives
- Elucidate the effect of dividend distributions on the pricing of options.