This question and answer are far from clear, and without the specifics we are more or less arguing that possibilities are certainties.
When a dividend is "paid" there are two effects:
- share value immediately drops by amount of dividend (actually occurs at ex-divided date)
- the market uses the new information to revise its views on the value of the future dividends/share value (can be said to occur at announcement date of dividend, but even so the dividend may have already been anticipated)
The latter could have various effects. For example, if market believes the reduced dividends are simply the company retaining more for higher growth in future, shares may go up. If reduced dividends suggest that all future dividends may be smaller, the share price will fall.
It's anyone's guess as to what the latter effect is and what the combined effect of the two effects above is on share prices.
Specific to this question:
I just had a look at the original question Sep 03 109 Q5(iii) which says
State the factors that might cause the time value to increase with no change in intrinsic value
A key bit of information here is that the intrinsic value is the same, ie current share value is the same.
I believe they are talking about past dividends here, ie option price change on paying dividends.
Say the share price is 1.10 and we are about to pay a dividend.
Say market expects that dividend will be 10p, and all goes as expected, the price will drop to 1.00.
If dividend instead is 0.05 we would expect the price to drop to 1.05, but price is actually 1.00 since the intrinsic value is unchanged. So the market has reduced its current value of the share (plus dividend just paid) and by extension the future expected value of the share is lower.
Total put value goes up, so time value goes up since intrinsic value is the same.
I'm fairly confident that the above is correct, but not completely so I welcome any counter arguments.
Last edited by a moderator: Sep 23, 2009