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Arbitrage: Part II

In part I of this series we defined arbitrage as the simultaneous purchase and sale of an asset to profit from a difference in the price. It is a trade that profits by exploiting the price differences of identical or similar financial instruments on different markets or in different forms. Arbitrage exists because of market inefficiencies. We viewed these market inefficiencies from the perspective of call and put buyers when in-the-money strikes traded less than parity. In this article, we will add the element of dividends into the equations and explore when arbitrage opportunities may arise.

The assumptions in this analysis is that strikes are in-the-money, the time value of the option is less than the future dividend distribution and the dividend ex-date is prior to contract expiration.

dividends and covered call writing

Dividend Ex-Dates in our Premium Reports


Early exercise and arbitrage opportunities for call buyers

Let’s set up a basic example with the following hypotheticals:

  • Stock BCI trades at $40.00
  • The $30.00 call has a premium of $10.25 (time of $0.25)
  • The dividend distribution will be $0.50

Initially, early exercise appears to make sense because we are benefitting by the $0.50 dividend distribution which is greater than the $0.25 of time value that can be captured if the option is sold. In this scenario the arbitrage opportunity involves exercising the call (losing the $0.25 of time value), buying the stock and seemingly benefitting by $25.00 per contract. In reality, it is a breakeven because share value will decline by the dividend amount.

The reason this does not represent the best arbitrage opportunity is because the option can be sold (capturing $0.25 of time value profit), the stock purchased prior to the ex-date and then the dividend distribution can also be captured for a seemingly net gain of $0.75. In reality, the gain is $0.25 because share value will decline by the dividend amount. Please note that in both instances, share value will decline by the dividend amount. Capturing the time value of the option premium is the advantage of this latter approach. An example of a price decline on the ex-date is reflected in the screenshot below:


dividends and covered call writing

Costco Price Decline on the Ex-Date

February 6th was the ex-date for Costco Wholesale Corp. (NASDAQ: COST). The blue arrow highlights the price decline resulting from the upcoming dividend distribution.


Why are we concerned about early exercise as it relates to ex-dates and covered call writing?

Many retail investors are not aware that both time value and dividends can be realized and therefore submit exercise notices when the dividend is greater than the time value component of the option. To protect ourselves from potential tax issues in non-sheltered accounts we must factor in this possibility even though it is remote and not the best choice for the call holder.


There may be arbitrage opportunities for put buyers

First, let’s set up a basic example with the following hypotheticals:

  • Stock BCI trades at $30.00
  • The $40.00 in-the-money put has a premium of $10.25 (time of $0.25)
  • The dividend distribution will be $0.50

The put is purchased at $10.25 and the stock is purchased at $30.00. On the ex-date, the put is exercised, selling the stock for $40.00. Since the stock was owned on the ex-date, the dividend will be captured on the pay date. The arbitrage results in a credit of $0.25:

[($40.00 – $30.00) + $0.50] – $10.25 = +$0.25



Arbitrage opportunities may be available to put buyers when the time value component of the option premium is less than the dividend about to be distributed. When writing covered calls and ex-dates exist prior to contract expiration, there is no advantage to early exercise for the call buyer but retail investors may make the choice to exercise early to capture the dividend despite the fact that this is not the best choice.


Upcoming speaking event

Orlando Money Show

February 8th –  11th, 2018

Click for information

I will also be part of the event opening All Stars of Options Presentations.


Market tone

 This week’s economic news of importance:

  • NAHB home builders index 74 (70 previous)
  • Housing starts for November 1297 (above expectations)
  • Building permits November 1298 (1316 previous)
  • Existing home sales above expectations
  • Weekly jobless claims 245,000 (above expectations)
  • GDP revision to 3.2% (3.3% expected)
  • Leading indicators for November 0.4% (previous 1.2%)



Mon Dec 25th

  • None scheduled

Tue Dec 26th

  • Case-Shiller home prices for Oct

Wed Dec 27th

  • Consumer confidence index for Dec.
  • Pending home sales Nov.

Thu Dec 28th

  • Weekly jobless claims
  • Chicago PMI for Dec.

Fri Dec 29th

  • None scheduled


For the week, the S&P 500 rose by 0.28% for a year-to-date return of 19.85%


IBD: Market in confirmed uptrend

GMI: 6/6- Buy signal since market close of August 31, 2017

BCI: My portfolio makeup moves to a bullish bias with the passage of the tax bill which should be a positive for the stock market, selling 2 out-of-the-money strikes for every 1 in-the-money strike.


The 6-month charts point to a slightly bullish outlook. In the past six months, the S&P 500 was up 10% while the VIX (9.90) moved down by 5%.

Happy holidays to one and all,

Alan and the BCI team



About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

25 Responses to “Arbitrage: Part II”

  1. Jay December 23, 2017 11:07 am #

    Good Morning Friends,

    As one of the old buzzards hanging around this blog for years I want to wish everyone Merry and Happy Holidays! Thank you as always for the insights and help you gave me this year.

    I am not Nostradamus or Einstein. But it will not surprise me if we have greater volatility to manage next year. As premium rises I can think of no better side of the trade to be on than selling it.

    But for the next couple weeks when things are quiet and people take well deserved vacations a Santa rally would be nice 🙂 – Jay

    • spindr0 December 23, 2017 11:29 am #


      This week, Edward Jones was advising its clients to be prepared for a return of volatility. They also noted that the largest dip in the stock market this year was just 2.8%, the first year without a 3% decline. It sure would be nice to see volatility return to normal levels and provide some additional premium for sellers.

      Happy Holidays


      • Jay December 23, 2017 12:43 pm #

        Thanks Spin,

        I am very glad you joined our community!

        My biggest 2017 winner is SVXY which, as you know, shorts the almost ever present contango in the VIX futures curve making the long products like VXX and UVXY consistent losers that have to reverse split all the time to prop their price back up. Try explaining that at a holiday party :)!

        Yet the VIX historical mean is more around 15 ish. But it can remain low far longer than volatility bulls can stay solvent. So we shall see how it plays out. I sell CSP’s on SVXY all the time but not CC’s because when the VIX stays low it just rocks on. But all great concerts end sometime :).

        I am positioned long into year end, didn’t over write much at these premium levels since you have to sit right on top of things to make it worth while, particularly index ETFs.

        If any one here has had their favorite team eliminated from the Playoffs we folks down here in Now Orleans on the ‘ol Bayou love new Who Dat’s (a local term for Saints fans) and hope you join us in cheering the Black and Gold the rest of the way! – Jay

        • spindr0 December 26, 2017 2:38 pm #


          I only know the basics about VIX and related products. Most of it is above my pay grade. If you’re going to try to explain it at a holiday party, wait until they’ve had several drinks. That’s when it will make the most sense to partygoers. That’s also about the time when they think that they can dance and sing competently :->)

          My earliest recollection of your beloved Saints was during the 70’s when they were led by Archie Manning with his cannonball arm. They were so bad that those attending the games wore paper bags over their heads and called themselves the New Orleans Aints. If memory serves, their best record for a season during that decade was 8-8. Particularly galling was 1979 (?) when they narrowly avoided going 0-16 by beating my NY Jets by one point. Well, at least he taught his children well (Peyton and Eli). Good luck in the playoffs.


          • Jay December 26, 2017 5:17 pm

            Thanks Spin,

            Your memory serves you well: they were once the “Aints” and fans in the Dome wore paper bags over their heads like the “Unknown Comic” on the Gong Show – remember him:)?

            Between their history and Hurricane Katrina when the Saints finally won the Super Bowl after 43 futile years it was cathartic and uplifting for this city to say the least. Archie is alive and well doing radio shows during the season. Geaux Saints!

            I can’t chart it, I can’t explain it and I can’t put a rational finger on it but I feel a “Tremor in the Force” in 2018 for the market. We will just have to play it one expiry at a time. – Jay

  2. Barry B December 23, 2017 8:52 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 12/22/17.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:


    Barry and The BCI Team

    [email protected]

  3. Justin P. December 24, 2017 8:01 pm #

    Still some bullish charts with decent premium out there if you turn over enough rocks. SHOP and WIFI still look bullish overall in spite of turning somewhat against me in the early going:

  4. roni December 25, 2017 9:28 am #

    Hello Justin,

    I checked WIFI and SHOP. They both look very interesting as long term investments.

    For my style of monthly income, I noted that SHOP has very low OI for ATM calls.
    For WIFI, I see nice OI, and nice ROO (2.9%) for ATM calls.

    Thank you for these tips.

    Merry Xmas – Roni

    • roni December 25, 2017 9:31 am #

      Sorry, forgot to state expiry.
      It is for 01/19/2018.


    • Justin P. December 25, 2017 10:50 pm #

      Hi Roni,

      Yes I’ve not been focussing on OI as much, more on a bullish chart, good ROO, reasonably tight spreads and preferably good DP. WIFI was offering a better ROO last week – here’s what I got when I opened each of the positions:

  5. Alan Ellman December 26, 2017 8:46 am #

    January 2018 edition of our Blue Chip (Dow 30) Report now available

    Premium members,

    The latest Blue Chip is now available in the “resources/downloads” section of your members site (right side). One stock was deleted and 3 stocks added from last months report.


  6. Marta December 27, 2017 11:32 am #

    Hi Alan,

    I am a BCI member and receive your weekly stock list. I often wonder about when to purchase stocks. Do I look at the list and just go ahead on Monday buy the shares and write the covered call? Or should I wait until the stock pulls back to a support level and then purchase. I often see the stocks being up over the 10/20EMAs in a quite overbought territory. Should I care at all where I enter?

    Thank you so much,

    • Alan Ellman December 27, 2017 12:37 pm #


      We should definitely consider the timing of when we enter our positions. Since we are undertaking 1-month obligations (some of our members use Weeklys), time value erosion of our premiums (Theta) must be factored in. Each calendar year there will be 8 four-week contracts and 4 five-week contracts. I enter my positions on Monday or Tuesday of week 1 of the new monthly contract. There is a little more flexibility with 5-week contracts but I still enter early in the week.

      Some of our positions may have been rolled forward from the last week of the previous contracts.

      When there is concern from a technical perspective, we can use in-the-money strikes for added protection.


      • Marta December 27, 2017 3:41 pm #


        Thank you so much for your quick reply. It all makes sense now. I am looking very much forward to your new book on poor man’s covered call writing. Wishing you and your family a very happy and healthy new year! Marta

    • Jay December 27, 2017 1:43 pm #

      Hi Marta,

      Something a few of us have discussed in the past and is just another idea to consider depending on your time frame is what I call “Buy/Wait”.

      Since I intend for longer than one expiry holding time and do not turn my portfolio over as often as traditional covered call writers might I buy the target stock/etf on a down day or at a support level and then let it go up a bit waiting to write the call until after it has some paper gain to play with in strike selection. I may wait into the next month or the one thereafter on a new holding before I start over writing it. I often skip months if I am bullish on it. I have been over writing my GLD, for example, all year but skipped it this month for seasonal reasons. Who ever thought of GLD as an “income holding”:)?

      So it is just another example of the flexibility in the strategies.

      But if you intend to maximize option cash flow month to month then Alan’s method is best since theta decay is our friend. We never know where a stock will go day to day but we do know the clock is ticking! – Jay

    • roni December 27, 2017 2:54 pm #

      Hello Marta,

      I do it exactly like Alan says, because on the first Monday/Teusday after expiry Friday, the premiums for the next options cycle are normally the best you can get.
      As Jay says, the clock is ticking, and premium decay is working for us.

      Needless fo say, I’m a month to month cash flow person.


      • JustinP December 27, 2017 11:35 pm #

        Roni, since you’re one of the few non-Americans posting here, do you convert each trade’s value back to your Brazilian currency for tax purposes? (I make sure I enter the current value of AUD for instance every time I make a trade on a spreadsheet.)


        • roni December 28, 2017 9:42 am #


          I am not sure that I’m doing it correctly.

          I declare all my cash and investments (one bank account, one Mutual Fund + Schwab end year statement total account value) on my annual declaration to the Brazilian Central Bank in US$.
          This is required for any Brazilian citizen who has more than U$ 100K overseas.

          In my Income Tax declaration, I do convert this total to our local currency, the Real, (pronounced ree-al), and if the total has increased from last year’s declaration, I will pay the related tax, which I believe is 15% (ceiling) on the gain.

          I must talk to my tax advisor ( she is my neighbor, and is a director at Ernest&Young – EY. Very convenient).

          Will keep you informed.


    • MarioG December 29, 2017 5:41 am #

      Marta, Now that Alan and several members have responded it is my turn to put my 2 cents in. It’s great when a member asks a question and you get differing view points. Different minds will pick up “positive” points from everyone’s comments

      I have been using Alan’s plan for 18 months and am normally 92 % invested. Many time the 92% invested point will not come till the second week. Takes time to do things or I am just waiting for a market down swing for a general news event to get better choices that will swing back in my favor further. I follow Alan’s recommended ratio of ITM to OTM and will go for high ITM trades at times to be more conservative and not get “greedy”.

      Of course, ideally it is preferable to trade CC in Week1, looking for a position with 2-4% of ROO. But I find, if you look well from the list in the Run list, you can do that even 2-4% in Week 2 of 4 or Week 3 of 5. For later in the cycle, you can look to 1.5% or higher in Week 3 of 4 or Week 4 of 5. 1.5% is 18% a year (assuming invested for whole month or higher if you enter later in the cycle) and I find that nice gain per year. Otherwise you money is in cash idle. Right at this moment 12/28, we are in Week 2 of 5. There is time to find good picks.

      That is the great thing about Alan’s run list and updates. It is “Up to Date” each week and reflects those stocks that are good picks to win from. Stocks which soured from last weeks list are purged.
      So if you find a ROO you like, trade a covered call for the current cycle. That is what we do anyway if a stock gaps up, has low time value and you look for a replacement.

      In a bullish or positive market:
      Another thing I look for when looking for a higher interest rate, is a stock in the run list that the current price is near a Strike value. That means to me less downside protection but higher ROO%. I then look at the price chart, calculate the trade’s Breakeven BEP, and see the stocks trend and past history visually. Trending Upwards: good safe bet to trade ATM. Trending sideways in general or in a consolidating mode, I look at the BEP and compare it to the price chart to see if I am most likely safe. Many times I find the BEP is far down the price chart for a good trade.

      One more thing, to speed up my stock selection, I enter the Run list in every week before Monday open bell (Prices automatically are entered) to help me select most likely good picks before I do the calculations..

      That is my 2 cents.

      Good luck with your trading – Regards,


      • roni December 29, 2017 10:00 am #

        Hi Mario,

        your post is 100% on the mark, and very clearly explained.

        In my opinion it is worth much more than 2 cents.


        • MarioG December 30, 2017 6:38 am #

          Thanks, Roni.

          Until next year!

          Have a Happy to you and all! Glad to be in warmer weather here in Florida. New York was 19 degrees last time I checked.


          • roni December 30, 2017 8:47 am


            Happy New Year to you and your family.


  7. Alan Ellman December 27, 2017 4:54 pm #

    Premium members:

    This week’s 8-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options as well as the implied volatility of all eligible candidates.

    New members check out the video user guide located above the recent reports.

    For your convenience, here is the link to login to the premium site:

    NOT A PREMIUM MEMBER? Check out this link:

    Alan and the BCI team

  8. MarioG December 29, 2017 6:08 am #

    Alan / Barry,

    Are you posting a 2018 Options Expiration Calendar from the OIC? Noticed the 2017 version is not in your system.

    I searched and found the OIC 2018 calendar (downloaded and attached) is at:

    Looks great in color with my HP Envy 7640 printer.



    • Alan Ellman December 29, 2017 7:03 am #


      Thanks for the suggestion. I added the calendar to the “Resources/downloads” section of the member site as well as below.



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