Dividend Yield effect on call option value

Why if dividend yield decrease would increase the value of a call option?

Less dividend yield = more price appreciation = more expensive call option.

Think of it this way, if you are writing a call option on your stock, you would want to get more money if the price of the stock grows faster than a dividend paying stock that gets most of it’s returns in terms of distributions, and not capital gain.

1 Like

Dividend depletes the value of a stock. Now since the dividend yield is low, it means that the value of stock is more than what it would be if compared to the stock with a higher dividend yield. Taking this value of stock and putting it in the put call parity equation you can solve for call value. You will get the answer.

However if I as an investor see that a potential sotck I wannt to buy decreases its yield I would not buy it. Would not be the market as a negative sign and so the price would decrease?

so I see it as less dividend yield = less price appreciation

It is a debatable issue, but generally decreasing Div Yield is taken as a negative sign as Div is sticky.

An easy way of understanding effects of inputs on options is to think of the pay offs and how they are calculated… Knowing that volatility increases uncertainty and options are “insurance” therefore the volatility should increase option prices. Also, with respect to prices, excerise, rate and dividend… look at the payoffs of options

Call option = S - Xe^-rt put option = Xe^-rt - S

if a dividend will decrease the stock price, take the call option as an example… S - dividend Will make the stock price lower if call option payoff = S - Xe^-rt then a dividned should lower the pay off of an option therefore lowering the option value… This goes the same for put options if you just htink about the pay off of a put option … same can be thought about the risk free rate if the strike price is discounted at the risk free rate

Moral of the story… think of the option payoffs formulas when you’re thinking about effects of inputs on option prices.

Call option = S - Xe^-rt

Dont really get that formula…

Are you trying to put the formula for a synthetic European call option:

Co = Po + So - (X/(1+Rf))

Applying what you mentioned. Less dividend yield would decrease the pice (Po) and so the call option (Co). Agree on that.

However, going back to my first post and as stated on the notes “why less dividend yield decrease would increase the value of a call option”?

sorry by price i did not want to put (Po), but (So)… However, the rationality is the same.

Less dividend yield would decrease the pice (So) and so the call option (Co).

Dividend yield = D1/P. If the Yield decreases, the most probable reason for this is an increase in P since Dividend distributions are much less volatile than fluctuating stock prices. As you know, when price of a stock increases, the probability of the call related to that stock to be in-the-money increases, and since the value of a call option is basically S-X + Time value, the call option value and price increases.

Take the call option as example… to calculate a price of a call option, you would use a Binomial tree. if a dividend is going to lower the stock price it MUST lower the payoff of the option being priced by the binomial tree if the payoff at a certain point = S - X

Thanks everyone! I got it! For me they key was the answer of Gurifissu. Dividend yield = D1/P.

Thanks a lot !!!