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Review of Financial Studies
Year: 2010  |  Volume: 23  |  Issue: 1  |  Page No.: 271 - 303

Ex-dividend Arbitrage in Option Markets

J Hao, A Kalay and S. Mayhew    

Abstract:

We examine the behavior of call options surrounding the underlying stock's ex-dividend date. The evidence is inconsistent with the predictions of a rational exercise policy; a significant fraction of the open interest remains unexercised, resulting in a windfall gain to option writers. This triggers a sophisticated trading scheme that enables short-term traders to receive a significant fraction of the gains. The trading scheme inflates reported volume and distorts its traditional relations to liquidity. The dramatic increases in the volume of trade on the last cum-dividend day are facilitated by limitations on transaction costs passed by the various option exchanges.

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