In Wednesday’s sometimes accurate heat-seeking option markets, traders faced a “DELLicious” dividend impact situation in computer manufacturer Dell (DELL) following news the company begin paying its first-ever quarterly dividend. Starting in the third quarter of FY12, shareholders with receive $0.08 per share held, giving the name a yearly dividend yield of roughly 2.6%. For option traders, we’re unsure if the dividend is actually tasty for today’s bulls or not. One thing is for certain though, this kind of shift in pricing does mean calls are theoretically worth less and puts will be more prized, all else being equal.

A change in the dividend and its impact is most easily compared in the pricing of conversions and reversals. This is true because these arbitrage strategies consist of actual versus synthetic stock, which in turn, boils down to carrying costs and dividends for the period held. While other variables such as delta, vega and theta can’t be said to be eliminated, we can state that a trader trying to play a conversion or reversal for profit off one of those Greeks is going to be in for a serious challenge.

If one of the conversion market’s two primary variables change, either interest rates or more likely, a sudden dividend shift, such as with today’s surprise or in 2008 and 2009 when many companies cut their dividends; conversions and reversals, particularly longer-term ones whose pricing reflects more of the new information, will show the most dramatic shifts in pricing.  

To illustrate how this looks in the real world we can simply compare Dell’s close-to-close conversion markets for any number of its January 2014 strikes and whose options are now pricing in a handful of quarterly dividends compared to last night’s count of zero payouts. Using mid-market prices from Tuesday evening and shares at $11.97 we can put together a table detailing conversion prices prior to the dividend news:

Figure 1: Dell (DELL) Conversion Markets Pre-Dividend News

While some of deep markets in Dell options are loose when comparing the bid to the ask price, the resulting conversion markets using mid-market prices show uniform and slightly increasing credits as we go up in strike price. Incidentally, that small incremental change is tied to the possibility of early assignment which is more likely with a deep call versus one that’s out-of-the money.

In today’s session and armed with fresh information of Dell giving shareholders a $0.08 dividend beginning in the third quarter, Wednesday’s conversion markets reflect entirely different pricing. Given the new dividend stream of $0.32 a year, the cost of ownership of shares is more desirable. In fact, the credit required for a strategy such as the conversion prior to the dividend, now means investors are willing to establish the arbitrage for a debit as the cost of carry is less than the potential dividend collection.

Figure 2: Dell (DELL) Conversion Markets Post Dividend News

Notice with the new dividend information how put prices on many strikes have risen in value despite shares lifting today, while the calls have settled lower, with the exception of the 3 strike call. Consequently and using the conversion formula, “Strike – Stock + Call – Put”, we can see how credit pricing has been revamped to reflect a new payout stream wherein a debit is now fair value. However, whether that pricing is really “DELLicious” and profitable remains to be seen and won’t be known until something like the iTV3 rolls around and investors still holding January 2014 conversions; settle their tabs with their brokers.       

Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
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The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual.