Caterpillar (CAT) options volume ahead of ex-dividend

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A look at options volume in Caterpillar Inc. (NYSE: CAT ) 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.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Options

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Jud Pyle

Jud Pyle

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