Whenever a dividend is declared on a stock, the market discounts the dividend in the market price of the stock and hence the ex-dividend price of the stock is lower. Now consider the situation where a future cash dividend of $3 has been declared on each share of Apple Inc..
The effect of dividend is not of much importance in case of European Options as they can be exercised only on Expiry Date.
The binomial options pricing model provides a generalizable numerical method for the valuation of options and was first proposed by Cox, Ross, and Rubinstein (1979). For the last step in the binomial lattice, the payoffs are calculated using the formula for intrinsic value of an option - Max(S-K) for calls and Max(K-S) for puts. While this model can handle continuous dividend yields by simply factoring that value into its calculation of p, handling discrete dividends requires some extra work. The computation of option values proceeds in the same way for discrete dividends as it did before.
The original Black-Scholes option pricing model (Black, Scholes, 1973) assumes that the underlying security does not pay any dividends. The Black-Scholes Calculator & Simulator uses the expanded version of the model (Merton, 1973) that can price options on securities that pay a dividend. Dividend yield usually doesn’t change as quickly and as much as some of the other parameters (like volatility or underlying price), but if you need you can also simulate effects of dividend yield changes on option prices and Greeks. Alternatively, you can set the charts to display the effect of another input parameter (for example underlying price or volatility) and then see how the charts change if you set different dividend yield values in cell C12.
If you want the exact original Black-Scholes model (without dividends), just set dividend yield in cell C12 to zero.
Just ask an option trader holding a call option and you will know. Dividends have an adverse effect on call option prices. With the fall in the market price of the underlying stock, the put option becomes more attractive and hence the premium of such a put option rises.
At any point of time, the value of the option is the maximum of the value calculated via its child nodes and the intrinsic value of the option. The calculation assumes that the underlying security pays a continuous dividend at the rate you set as entry parameter.
I assume you have some idea about options and must be aware of the basics of options trading.
This in turn results into decrease in the price of the call option attached with the stock.
If we calculate the premiums of options of Apple Inc for the September 21st, 2013 at-the-money contracts ( i.e. It can be observed clearly in case of American Options because of the fact that you can exercise the option before the expiration date as well.
The effect gets neutralized in case of a covered call as the decrease in option prices is compensated by the dividend received on the stocks.
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