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Equity Derivatives Anatomy™

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The date on which a Share trade is priced to exclude a the value of a declared, forthcoming but as yet unpaid dividend, on account of its record date having occurred before a trade printed today can settle to the buyer’s account. A buyer of an ex-dividend Share will not become the holder of record until after the record date, and so won’t get any dividend payment, even though the Dividend Payment Date may fall after the buyer comes to hold the Share, so shouldn’t jolly well have to pay for it.

A buyer of an ex-div share, being homo economicus, won’t want to pay for the implied cost of that pending dividend. Hence, the share is said to trade “ex-dividend”.


Interestingly, there is a SNAFU in the Dividend Amount provisions of the 2002 ISDA Equity Derivatives Definitions — there is a cacophony of cataclysmic SNAFUs there, truth be told, meaning that none of the payment triggers in that section — the Ex Amount, Record Amount or Paid Amount — make a great deal of sense. See Dividend Amount for more on that riveting topic.

Coronavirus now: redux

You are a counterparty to an equity derivative Transaction papered under the 2002 ISDA Equity Derivatives Definitions. Hard to imagine, I know, but just go with me. So what happens if you have selected “Ex Amount” as your Dividend Amount payment method, and the Issuer has duly declared a Dividend, the record date has passed as expected, the Share has started trading ex-dividend (as by rights it should do) and then something unexpected and properly epochal happens — like the world basically ceasing to rotate on its axis for a prolonged and indeterminate time, prompting said issuer to cancel its dividend. What then?

Judged by the lights of its basic metaphysical premise, the intention of a derivative is to, well, be derivative: to replicate as closely as possible the performance of the underlying Share. No equity derivative counterparty has it in its head that it is underwriting, or guaranteeing, an Issuer’s commitment to pay a dividend that the Issuer itself does not ultimately carry though — even if the Issuer were legally obliged to perform that obligation, whereas in fact it tends not to be (however unconventional not doing so might be). So, you would think, it would be odd to find a Transaction obliging an Equity Amount Payer to pay a Dividend Amount notwithstanding cancellation of the actual dividend on the underlying Share.

To be sure — we men and women of finance being homo economici and everything, you would expect anyone writing that kind of put option to be pretty categorical about it, and to demand quite some premium for it.

Yet a cold reading of the Ex Amount method (if not modified by some kind of clawback) suggests that it what it does:

100% of the gross cash dividend per share declared by the Issuer to holders of record of a Share where the date that the Shares have commenced trading “ex-dividend” on the Exchange occurs during the relevant Dividend Period”.

Dunno about you, but I can’t see any contingency on actual Issuer payment in there.

The above “cold reading” does not accord with the economic facts as market participants — homo economici all — understand them. The JC suspects that common sense will prevail and no one will be cavalier enough to take this point. But you just never know, and it is a hard one to crowbar into the present law of contractual mistake.

See also

  • Dividend Amount, which goes into all of this in some really quite tedious, not to mention stupendously erroneous, detail.