Black Scholes model to value dividend paying stocks

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Victoryeo1984

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When we use Black Scholes model to value dividend paying stocks , do we need to account for the dividends , or simply ignore the dividends?
The original Black Scholes version ignore dividends, but the adapted version could reflect the dividends by deducting the present value of dividends from the stock price.
 
Check the official curriculum
One question was solved considering the aforementioned scenario
 
I read the official curriculum on “option markets and contracts”, can’t find the question related to dividends.
 
My Schweser material mentioned that calls on dividend paying stocks are cheaper than calls on non-dividend paying stocks and puts are more expensive, all else being equal. Their rationale was that a higher payout ratio means lower ROE so a call is less likely to move into the money. I can’t recall exactly where this was in the text though.
 
Higher payout ratio means lower ROE? Why is that?
I thought calls are cheaper and puts are more expensive because any dividend automatically decreases price :)
 
Sorry! Lowers growth…not ROE! The book presented it as g = (1-b) x ROE and g lowers with an increased payout. It would also make sense that the decrease in equity value from a dividend would result in lower call prices but two companies with the same equity book value could still have different values for calls due to different growth prospects.
I have also realized that the authors were applying this concept to options in general and not the BSM. So basically ignore everything I just said. Schweser regarding the limitations of BSM : “The underlying asset has no cash flow, such as dividends or coupon payments.”. They also mention that it is easy to relax this limitation by modifying the formula but, in general, there are no cash flows.
 
Dividends affect the price of a stock by lowering it. If the price of a stock goes down, then the call value goes down.
As opposed to interest rates, volatility, time to expiration, these all add value to the call option if they increase.
I’m not sure what the issue is.
 
blackscholesvol wrote:
Dividends affect the price of a stock by lowering it. If the price of a stock goes down, then the call value goes down.
Click to expand...
Yup - straight forward, conceptually.
Victoryeo1984: you can not use the original black scholes to calculate discrete dividend paying stocks because black scholes is a continuous model. However, you can back of the envelope the price by removing and discounting the dividend - I think this is what the adapted models do.
Hope this question isn’t related to the recent exam… :/
 
Moey wrote:
blackscholesvol wrote:
Dividends affect the price of a stock by lowering it. If the price of a stock goes down, then the call value goes down.
Click to expand...
Yup - straight forward, conceptually.
Victoryeo1984: you can not use the original black scholes to calculate discrete dividend paying stocks because black scholes is a continuous model. However, you can back of the envelope the price by removing and discounting the dividend - I think this is what the adapted models do.
Hope this question isn’t related to the recent exam… :/
Click to expand...
Just discussing concepts from the curriculum regarding Black Scholes. My userrname is in fact Black Scholes
 
Share repurchases are one use of FCFE. Dividends are another.
 
You can either remove continuous dividends from the stock price while calculating the call/put price.
Alternatively, you could remove continuous dividends while calculating N(d1) and not remove it from the stock price.
 
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