A look at options volume in
Caterpillar Inc. (NYSE:
today shows more than 15,000 August 30 calls traded versus open
interest of 252 contracts and 12,000 August 49 calls crossed the
tape versus open interest of 295 contracts. With the stock priced
around $66.51, down 19 cents on the day, you might ask, "Was this a
bullish investor buying calls that are way-in-the-money instead of
buying stock? Or was it a bearish investor selling
calls instead of shares?"
The answer, in fact, is neither. The action we saw today
was neither bullish nor bearish. Instead, it was a trade
designed to take advantage of the fact that shares of CAT will
trade ex-dividend tomorrow. Because the shares will trade
ex-dividend, the August 30-strike and 49-strike calls are
technically an exercise. They are technically an exercise because
holders of call options do not participate in the dividend. So,
rather than hold the calls, the owner of the calls should exercise
them and get the shares, and get the dividend.
So, why all of the volume in the calls? Well, the answer is
because if the calls are an exercise, then that means that if
someone is short the calls and long the stock, they can make a
profit on any call that is not exercised.
Let's say that the $30 calls are worth parity right now, so that
is $36.51 with the stock at $66.51. If the calls that the option
market maker is short are not exercised, then the stock will fall
by the dividend amount. The stock in this case falls by 44 cents
(the amount of the dividend) so the stock falls to $66.07. The call
that the market maker is short also falls by the amount of the
dividend to $36.07. Since the market maker is long the stock (a
loser in the fall) and short the call (a winner in the decline) it
seems that the market maker has no economic gain. But the market
maker gets to pocket the dividend of 44 cents!
Based on what we just diagrammed, there is clearly a benefit to
being short the calls in case any of the open interest fails to
exercise. That is all there is to this trade; market makers are
trying to get short the calls so that they can be a part of the
open interest in each of those strikes. The volume that we saw
today was market makers buying and selling the calls with one
another. All of the trades record on the books as "open." The
market makers are smart enough to exercise their calls, and all
that is left is anyone who does not exercise.