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Ask Trader Guy: Trading Resolutions and Dividends

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January 1, 2011
trader guy call options dividends
Fredrik Broden

Q: Hey, Trader Guy! I've already broken all of my New Year's trading resolutions, and it's only been a week! Can I be redeemed?

A: You think you're bad, just ask my gut about that latest box of Twinkies. Anyhoo, it's safe to assume that just like the varying degrees of debauchery that spur New Year's resolutions, it's trading losses that prompted you to create your trading resolutions. Discipline in sticking to a trading game plan is tough to get and challenging to keep. Even the best traders falter. But sometimes they bend the rules to come up with even better ones. If you keep losing money when you break your rules, stop it. But if you keep losing money and you're following your rules, a review might be in order. Also, consistently breaking the rules might mean you've learned something new, and need to change them. Redemption? You've got the rest of the year. As for me, I swear not to eat anything that has a fat content of more than 20 %. But if I end up sucking on a stick of butter in a time of weakness, I'll just hit the treadmill. My doc gives me a year, too.

Q: Hey, Trader Guy! I read that when a stock has a dividend, its calls are cheaper. Why?

A: The simplest way I know to explain this is to think of calls as alternative to stock. It's not exact, but if the stock goes up, assuming they're not too far out-of-the-money, calls tend to go up too (all other things being equal). If a stock pays a dividend, then the cost of owning that stock goes down. You're either borrowing money to buy the stock, or you're using cash that would otherwise earn interest. Those interest costs are reduced when the stock pays a dividend. So if it costs less to own the stock, then it's less advantageous to buy the call as an alternative. The call, then, is cheaper.

A fuller explanation is that the put is worth more when there's a dividend. A long call that's cheaper and a short put that's more expensive means the synthetic stock (long call, short put, same strike and expiration) is cheaper. The price of the synthetic stock is based on the cost to own the stock for a certain amount of time. The dividend reduces that cost, so the synthetic is cheaper. That can happen when either the call is cheaper or the put is more expensive.

Q: Hey, Trader Guy! In light of my recent trading performance, I'm weighing some of my housing options at the moment, and have decided to “go green.” What's my carbon footprint if I live in my car?

A: So much of environmental friendliness is about multi-use, meet-your-needs, replica-ble lifestyle choices. Once the housing of upscale vagrants, car-living is poised to become the easy, fast way to get LEED certification in the future. It's like a battery-powered, mobile greenhouse. I applaud you for your pioneering spirit. And if your trading turns around, all you'll need for a home makeover is some air fresheners and fuzzy dice.