In Monday’s session and amidst a third session of bulls trying to convince other bulls the bull was indeed back, Microsoft (MSFT) saw gargantuan levels of calls trade. Compared to its total daily contract average of about 123,000, overall volume swelled to nearly 850,000 with more than 90% of that activity being in the calls. The surprise or really lack thereof; when pulling up MSFT’s options and scrutinizing the raw data was the bulk of that trading was undoubtedly tied to dividend plays.
In front of today’s ex-dividend of $0.16, the dividend play attempts to capture the dividend, esoterically, through the use of unassigned deep calls which are hedged with stock i.e. a buy-write. The trick, which requires a great deal of Lady Luck and a professional commission schedule to consider participation in this game, revolves around the agreed swapping of deep in-the-money calls with no time value or time value less than the dividend being paid, as well as large existing open interest.
Traders trying to capture the dividend will exercise their long calls on matched up verticals in the hope the long call contract holders from the existing open interest pool forget or decide not to exercise in order to collect the payout. If this scenario plays out as hoped for, the trader will in affect have established a buy-write worth the dividend on a strike where actual market prices hold lesser to non-existent put values i.e. the risk equivalent of a buy-write when short.
How do I know this? Some years ago as a market maker in Phillip Morris (PM), capturing the dividend was a popular quarterly game I participated in regularly. With a decent sized payout, low volatility, typically large pools of open interest and ultra low trading costs; it made good economic sense to play. I can say that typically one or two other market makers would get away with unassigned calls and land a sizable overnight payout. However, the vast majority of the participants (including myself) establishing the massive and excited-looking contract volume, would end up footing the bill or maybe find they had enough unassigned calls as to buy lunch the next day.
In today’s much more wired-in and sometimes sophisticated market, getting away with the dividend without having to take on too much risk by involving strikes with actual time premium (put value) close in price to the actual payout; is all the more difficult. That all said, some traders did get away with the August 20s and 24 calls last night.
Open interest of about 1,500 and 4,000 remain compared to prior open interest of 2,260 and 12,300 and heavy trading of 27,400 and 124,000 respectively. With the higher up strike’s put having a market of $0.04, a trader unassigned on the 24 call has a $0.11 or $0.12 profit on paper while maintaining the equivalent risk of a short August 24 put until expiration or until the risk is cleaned up. What we don’t know is if the lottery-style assignment process allowed for one or two big winners or a slug of much smaller winners or traders maybe just covering their costs.
More elusive and interesting than this common and overplayed game that I’ve been intimately familiar with from days past, was Monday’s heaviest volume in the January 2012, 12.5 and 15 call, as well as the January 2013 15 call. Massive matched up and parity-like prints between the three on total volume of 57,000, 151,000 and 182,000 went up in the last three minutes of the day. With mixed put values less than to more than double the dividend, “okay” open interest, some sort of attached delta to the three-way and virtually all that volume going “poof” through the exercise process; I’d be curious as to what both sides of those very fast money operations were thinking they were getting away with—or did, as it’s a mystery to me.
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
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