Get ready for the dividend season: Why call option holders should pay attention to AGM dates

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With DAX-listed companies alone set to distribute EUR 18 billion to shareholders in 2006, call option holders should take care to exercise their options in time.

Annual General Meetings (AGMs) of listed companies in 2006 will once again be pleasant for shareholders, with the constituents of the DAX alone set to distribute around EUR 18 billion to their shareholders this year. For holders of call options, however, dividends paid may dilute the value of their positions, unless the options are exercised in good time.

The coming months will see a concentration of dividend payment dates for German shares: 26 of the 30 companies included in the blue chip index DAX will distribute the dividends for the past financial year during the months of April and May. In the Swiss equity market, there is a similar concentration of AGM dates during the summer months, whereas Dutch and US companies generally distribute dividends on a semi-annual or quarterly basis.

High Dividend Distributions on European Stocks
Dividends to be paid by benchmark index DAX constituents in 2006 show marked increases compared to the previous year, reflecting good business performance across the board. Given that stock prices also rose, the average dividend yield for the blue chip index DAX has remained largely unchanged, at around 2.4 percent. The average dividend yield of the Dow Jones EURO STOXX 50 in 2006 is 0.5 percentage points higher than for the DAX ; this reflects the impact of energy and financial stocks such as the Dutch ING Groep and ABN Amro. A further boost has been provided by European telecommunications operators such as France Télécom and Telecom Italia, distributing dividends in excess of five percent, just like Deutsche Telekom.

Timely Exercise of Calls is Important
Eurex offers stock options on approximately 175 underlying stocks from eight countries, plus around 80 single stock futures. Dividend payments have a different impact on these products. The contract specifications for futures on single stocks provide for cash settlement at maturity, with no dividend distributions. Accordingly, price markdowns due to expected dividend distributions during the lifetime of the futures are already discounted in the futures price.

The situation is different for stock options. Options traded at Eurex are American-style options: The holder of a call option generally has the right to exercise at any time during the option's lifetime, demanding delivery of the underlying shares. For options on German stocks, this right is only excluded on the day of the Annual General Meeting. Consequently, holders of deep-in-the-money call options on a stock (where the exercise price is significantly lower than the current stock price) should exercise their options ahead of the AGM date. Failing to do so would mean losing dividend claims, as illustrated in the following example.

Investor A holds 1,000 Deutsche Telekom shares. Assuming that the company will pay the announced dividend of EUR 0.72 per share in early May, the share price will be marked down by this amount on the ex-dividend date (all other factors remaining unchanged). Assuming an Xetra closing price of EUR 14.00 on the day of the AGM, the expected opening price for Deutsche Telekom shares on the next trading day would be EUR 13.28. As investor A receives the dividend distribution, this markdown has no net economic impact.

The situation is different for investor B, who holds ten June 2006 call options with an exercise price of EUR 12. The options represent the right to purchase 1,000 Deutsche Telekom shares at a price of EUR 12. If investor B exercises the option position prior to the dividend payment date, he will realize a profit of EUR 2 per share. Although the value of the shares will fall on the ex dividend date (due to the dividend markdown), this will be equalized by the dividend claim, as is the case for investor A.

However, should investor B fail to exercise in good time before the dividend payment date, the option's intrinsic value will fall on the ex date, in line with the dividend distribution - without any offsetting dividend claim. It is thus preferable to exercise deep-in-the-money call options (or, alternatively, to sell them) ahead of the dividend payment date. Otherwise, call option holders will lose their claim on the dividends payable on the underlying shares - leaving the benefit with the seller of the option.

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