Failure to exercise call options: An anomaly and a trading game

In the US, exchange-traded options are unprotected from cash dividend payments on the underlying stock. Consequently, it may become optimal to exercise deep in-the-money call options just prior to the ex-dividend day. In this study, we examine the extent to which option holders fail to exercise their call options on the day prior to an ex-dividend day when it is optimal to do so. Using a sample of call options on stocks with quarterly dividends of at least a penny per share during the period January 1996 through April 2006, we find that more than half of outstanding long positions go unexercised. We estimate that this failure to exercise has caused call option holders to lose over $491 million over a ten-year period. We also show how market makers capture the lion's share of the proceeds by using a dividend spread trading strategy.