It looks very attractive to buy a stock and write option for companies like FRO which pays
hefty dividend in the range of $2-$5.
If FRO trades at 60 and call option for strike price of $35 would be around $25 and it looks
like there is very little chance that the FRO would fall to 35 and you can collect dividend of $3
which is almost 10% of your cost for a month. Sounds very good and there is only 0.01% chance
that FRO will hit 35. This sounds too good to be true.
So what is the catch here?
If the dividend is cash the option price will not be adjusted. The dividend goes to the stock
holder and option holder will not get any dividend but the chances are the stock price will
trade lower by the amount of dividend. So why would the option holder will hold the option
and let you enjoy the dividend. So this what happens. On the ex-dividend date the stock
will be assigned to the option holder.
There is no free money here. Do not play this game for a company like FRO. But it will work
for companies which pays around 5% dividend.
