The big trade Tuesday was massive call volume in Verizon (VZ) and AT&T (T), particularly in the January in-the-money (ITM) options that basically carry a 100 delta (i.e., they are virtually stock). In fact, volume was so high that it dwarfed the pre-existing open interest in both names.

To add even more intrigue, both names found themselves all over the newswires thanks to Google (GOOG) unveiling the new Nexus One smartphone.

At first glance, you might be thinking this looks like smart money loading up on calls.

Nope. It’s just some dividend-capture plays. Say what?

Yes, the timing was quite coincidental, but both names traded ex-dividend on Wednesday. For VZ, that’s a 45-cent dividend, while T had a 41.5-cent dividend.

The Appeal of the Dividend Play

The idea behind a dividend play is to find a virtually risk-free way to get short calls on a strike with decent open interest, and hope the pre-existing owners do not exercise them.

For example, let’s say you buy 10,000 shares of AT&T stock and short 100 T Jan 25 Calls (TAE) for parity to where you bought the stock on the day before T goes ex-dividend (Tuesday).

Now, let’s say Wednesday comes along and you get assigned 90 of the calls. That wipes out 9,000 shares you own, but leaves you long 1,000 shares and short 10 calls. When T pays out the dividend, you will collect it 1,000 times ($415).

Your risk is that you now have the January 25 buy-write on 10 times, but the T Jan 25 Puts (TME) trade for only 3 cents (on Tuesday), so you could theoretically buy 10 puts and essentially close out the trade. That will cost you $30 (not counting commission), so you’ve pocketed $385.

It all sounds too good to be true. And, of course, it is.

The Odds Are Not in Your (or Anyone Else’s) Favor

The odds of you “getting away” with 10% of the T calls you short are about the same as the odds of Alyssa Milano ringing my doorbell this afternoon. In other words, pretty close to zero.

That’s because an awful lot of traders had the same idea here. In fact, 1,353,781 calls traded on Tuesday, and the pre-existing open interest in the calls was 47,514.

Remember that for every call that traded, we had a buyer and a seller. And we can presume anyone who bought calls on Tuesday will immediately exercise them (we’ll assume also that no one had a clerical error, though those do happen from time to time).

So the only “play” is on calls owned before Tuesday. With open interest the of 47,514 calls before Tuesday, if we assume every call owned before Tuesday goes un-exercised, and every call traded Tuesday gets exercised, then we can say the odds of “getting away” with a call are 47,514/(1,353,781+47,514), or 3.4%.

The odds were even worse on the most active VZ series, the VZ Jan 30 Calls (WLRAF), as 1,002,200 traded to capture with a pre-existing open interest of 28,100 calls, making your odds about 2.7%, assuming the same scenario we did for the T calls.

But even those chances of success are inflated. Most call owners (whether they bought before or after Tuesday) know to exercise, and, in fact, all but 761 T calls were assigned, meaning your real odds of getting away with anything was more like 761/1,400,000, or about .054%. In VZ, 338 calls went unassigned, making your odds about .033%.

Now, it’s great for the lucky (very) few that did escape and capture a few dividends. But, alas, we have not considered expenses.

A Lot of Work for Little Return

Virtually all ex-dividend trades go up in huge blocks, so they will just get a reasonable maximum ticket charge (as opposed to charge per contract). You will probably need a live human to execute the trade, and he’ll probably work on an arrangement where he will get a piece of any calls you get away with, rather than a commission (he’d love a commission on the huge spread, but no one’s going to pay it).

You also will likely owe your clearing firm exercise and assignment fees, although those will also surely be capped.

None of these charges will prove cosmic, but it’s likely that’s all you’ll walk away with as you must do many, many dividend plays in many, many names before getting away with a scant few calls.

All in all, it’s a modest expense and an awful lot of trouble to make a relatively small return. But, hey, it does ramp up the volume!  

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