From the May 01, 2011 issue of Futures Magazine • Subscribe!

Dividend options and futures

Debate continues whether dividends can be interpreted as their own asset class, separate from stocks and other equity-related products. The discussion has achieved a new perspective recently thanks to the introduction of new instruments, such as dividend futures and options. These products have been introduced on many European-listed equities and are coming to the United States. Their function is simple; they enable investors to trade dividends independently of the underlying stock.

Dividend estimates are, therefore, not only of interest to equity investors who want to earn a steady income, but they also play a significant role in derivatives pricing for equity forwards, futures and options as well as dividend futures and options. As changes in the price of the underlying usually dominate the price of an equity option or futures contract, the effects of changes in implied dividends often are overshadowed or ignored.

If investors want to avoid equity risk and implement a strategy based on their view of future dividend payments, they can choose between different approaches:

  1. Investing in a long spot (including financing) and short equity forward combination, which practically equates to a dividend swap.
  2. Using long/short combinations of different equity forwards/futures, which would lead to dividend exposure between the two expirations.
  3. Buying and selling equity options based on put/call parity (see "Between puts and calls," ).
  4. Using new instruments such as dividend options or futures.

Prices and dividends

Using different maturities for equity forwards/futures (or, equivalently, equity option pairs) on an index leads to a term structure for implied dividends. The graph "Implied value" (below) illustrates the present value of dividends that are implied by prices of listed equity options on the S&P 500 using put-call parity.

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