Options trading offers numerous strategies for investors to generate income and manage risk. One popular strategy is trading call credit spreads. However, traders must be aware of potential risks associated with ex-dividend dates. This is a topic I recently taught in my Inner Circle program. I realized a lot of people were unaware of this risk. So, in this article, we will explore the concept of ex-dividend risk and discuss strategies to mitigate the risk.

Understanding Ex-Dividend Risk:

When a company declares a dividend, it sets an ex-dividend date. This is typically a few days before the dividend payment date. Investors who hold the stock before the ex-dividend date are eligible to receive the dividend. Those who buy the stock on or after the ex-dividend date are not. This leads to a significant drop in the stock price on the ex-dividend date. This is because the dividend amount is essentially transferred from the company to the shareholders.

Ex-Dividend Risk in Call Credit Spreads:

When trading call credit spreads, the risk lies in the potential for assignment of the short call option due to the decline in stock price on the ex-dividend date. If the short call option gets assigned, the trader would be obligated to sell the stock at the strike price, potentially resulting in a loss if the stock price drops significantly due to the dividend payment.

Strategies to Manage Ex-Dividend Risk:

1. Adjusting Strike Prices: One approach to mitigate ex-dividend risk is to adjust the strike prices of the call credit spread. By lowering the strike price of the short call option, the chances of assignment due to the dividend-induced price drop can be reduced. However, this adjustment might also decrease the premium received, affecting the overall profitability of the trade.
2. Timing the Trade: Another strategy is to time the entry and exit of the trade relative to the ex-dividend date. Traders can avoid initiating a call credit spread too close to the ex-dividend date, minimizing the risk of assignment. Similarly, closing the position before the ex-dividend date can help avoid the potential downside.
3. Utilizing Dividend Risk Calculators: Several online tools and platforms provide dividend risk calculators that help traders assess the impact of dividends on option prices. These calculators consider various factors such as the dividend amount, ex-dividend date, and implied volatility, providing a quantitative analysis of the potential risk. Utilizing these calculators can aid traders in making informed decisions and adjusting their call credit spreads accordingly.
4. Diversification and Risk Management: As with any options trading strategy, diversification and risk management are crucial. By spreading investments across multiple call credit spreads on different underlying stocks, traders can reduce the impact of ex-dividend risk on their overall portfolio. Additionally, implementing stop-loss orders or setting predefined exit criteria can help limit losses and protect capital.

Finally, To Conclude…

Trading call credit spreads can be a lucrative strategy for generating income, but it is essential to be aware of the potential risks associated with ex-dividend dates. By understanding the concept of ex-dividend risk and implementing appropriate strategies, traders can navigate this challenge effectively. Adjusting strike prices, timing trades, using dividend risk calculators, and practicing risk management techniques are all valuable tools for managing ex-dividend risk when trading call credit spreads. Remember, thorough analysis, careful planning, and continuous monitoring are key to successful options trading.

Thanks for reading 🙂
Austin Bouley
CEO & Chief Strategy Officer