Special dividends unwrapped

One thing about the market is how it never fails to continue to humble Dr. Kris, especially when she starts to think she’s pretty smart. Take the recently declared $4.50 special dividend by OptionsXpress.*

[Special dividends are fairly rare events but companies sitting on a lot of cash have been declaring them this year so that their shareholders won’t be saddled with the tax burden of an increased ordinary dividend next year (now a moot point as just today Congress has agreed to keep the Bush tax cuts for at least the next two years).]

On 11/29, the day of the announcement, the stock jumped from $17 to $18.67 before settling back down to the $17.30 area which is where I bought it. Along with the stock, I purchased the January 15 put for 20 cents that (I thought) would more than amply protect the position. Doing the math, I was guaranteed at least a $2 per share return (11%)— that’s incredible!

There seemed to be no downside to this trade, so why wasn’t everyone and his uncle piling into it?  Was I missing something?

I finally found the answer today on the CBOE website where they state in a memorandum that because of the special dividend, all of the listed options strike prices will be lowered by the dividend amount.** Oh-oh. That means in a blink of an eye my fifteen dollar strike shrunk down to a size ten-fifty, a fact my broker neglected to mention when I placed the trade. The real kicker is that my broker is OptionsXpress!  Thanks a lot.

Essentially I’m flying without a safety net but I’m not too worried. I don’t think the situation is all that dire. The stock will have to drop to $13 before I start losing money which means busting through several areas of support including a major level at $14. The risk picture will become clearer as the pay date (12/27) approaches.

Well, I’m still looking for that free lunch, but on Wall Street the only way to get it is still the old-fashioned way–illegally.

* This dividend will be paid on December 27th to those on record as of December 13th. The stock goes ex-dividend on December 28th.

** The options strike reductions are also in effect for the following companies that have recently declared a special dividend: IBKR, RLI, STV.

Leave a Reply

You must be logged in to post a comment.