Hello, For part (ii) in the question, why do we take dividends into account? Do the dividends affect the share price? I would think that for a call option, the payoff for holder of the call would not be influenced by dividends because these occur before maturity and only the writer will benefit from dividends because they actually hold the share before maturity and the buyer of the call only gets the share at maturity? Am I missing a key concept? Many thanks!
Hi Bernadette, A call option means we are maybe paying K and getting the share, S. If dividends are paid, the value of the share S will go down, so by the time it gets to us it will be worth less. If I have the option to buy a bike for £100 and someone takes the wheels off it before I get the chance to exercise the option, I'm not going to be pleased. It's the same for shares and dividends - the bike is losing its wheels! (Or maybe just the saddle, depends on the size of the dividend ;-) ) John
