When we use Black Scholes model to value dividend paying stocks , do we need to account for the dividends , or simply ignore the dividends?

The original Black Scholes version ignore dividends, but the adapted version could reflect the dividends by deducting the present value of dividends from the stock price.

My Schweser material mentioned that calls on dividend paying stocks are cheaper than calls on non-dividend paying stocks and puts are more expensive, all else being equal. Their rationale was that a higher payout ratio means lower ROE so a call is less likely to move into the money. I can’t recall exactly where this was in the text though.

Sorry! Lowers growth…not ROE! The book presented it as g = (1-b) x ROE and g lowers with an increased payout. It would also make sense that the decrease in equity value from a dividend would result in lower call prices but two companies with the same equity book value could still have different values for calls due to different growth prospects.

I have also realized that the authors were applying this concept to options in general and not the BSM. So basically ignore everything I just said. Schweser regarding the limitations of BSM : “The underlying asset has no cash flow, such as dividends or coupon payments.”. They also mention that it is easy to relax this limitation by modifying the formula but, in general, there are no cash flows.

Victoryeo1984: you can not use the original black scholes to calculate discrete dividend paying stocks because black scholes is a continuous model. However, you can back of the envelope the price by removing and discounting the dividend - I think this is what the adapted models do.

Hope this question isn’t related to the recent exam…

You can either remove continuous dividends from the stock price while calculating the call/put price. Alternatively, you could remove continuous dividends while calculating N(d1) and not remove it from the stock price.

Just for clarification, what is the answer to the OP’s question? Not quite clear from the numerous responses above. Would you need to adjust the BSM model to account for dividends?