Last Updated on 20 October, 2020 by Samuelsson
Futures are considered to be a fairly complicated trading instrument. In fact, beginner traders usually avoid trading futures since it takes time and research to understand how they work. One common question which people ask is ‘Do futures give dividends?’, and while the answer seems simple on the surface, the reality is a lot more complex.
Standard futures contracts do not give dividends. However, the value of a futures contract can be affected by the dividend indirectly, even though the expected dividend has already been accounted for in the futures contract’s price. Nowadays, there are Dividend Futures as well which grant the purchaser the right to the dividend but not the underlying security.
Beginner investors should try to understand futures contracts as soon as they can. While futures contracts are often said to be speculative in nature, they can have their advantages too.
Here is our article on futures contracts!
One of the biggest advantages of understanding how dividends affect futures is that you will be able to spot opportunities previously unavailable. As long as you are able to viably ascertain if the dividend of a particular stock is going to increase or decrease, you will be able to make money by trading the futures market.
How Dividend Payments Impact Futures
Although futures contracts are priced after taking expected dividend payments into account, that doesn’t mean that dividend payments will have no impact on the price of futures. Whether your futures contract is based on a particular stock or an entire index, the idea is the same.
Why Does the Price of a Stock Fall on Dividend Dates?
The idea is very simple to grasp. Let’s take the example of Microsoft. Microsoft pays a quarterly dividend of $0.46 per share. This means that as soon as the dividend has been paid out, the book value per share has fallen by $0.46. This causes the price of the stock to fall as well. The amount by which the stock price decreases would be exactly $0.46 if the efficient market hypothesis was correct.
However, in reality, the stock price could fall for a smaller or larger amount than the dividend payment. In certain cases, the price of the stock might even increase (although this is usually due to other factors).
How to Determine a Futures Contract’s Price
The vast majority of futures contracts that you can purchase (or short) are based on price. This means that the entire value of the contract relies on the price of the underlying security and dividends do not generally have an effect on the price of the futures contract.
However, dividend payments usually affect the price of the underlying security in a negative way. This means that the futures contract will also suffer once the dividend has been paid. To combat this, futures contracts are priced in such a way that all the expected dividends are accounted for. As such, the price of a futures contract is affected only when the dividend is different than expected.
It is true that dividends have little to no effect on futures most of the time. However, dividends can occasionally impact a futures contract in both positive and negative ways.
When do Dividends Change the Futures Contract’s Price
Suppose a futures contract of Microsoft was purchased with an expected quarterly dividend of $0.40. This means that the futures contract was priced assuming a quarterly loss in book value per share of $0.40. However, provided that earnings and growth stay constant, an increase in dividend means a loss in book value that was previously unaccounted for.
As such, the price of a futures contract is going to fall if the dividend increases. Conversely, the price of the contract will increase if the Dividend decreases. This may sound complicated, but the next example should help clear things up.
How a New Dividend Affects Futures Price
Suppose there is a certain stock trading on NASDAQ that does not pay a dividend at the moment. At this time, the price of the futures contract will be roughly the same as the stock’s current market price.
When a dividend is announced, the price of the futures contract must shrink immediately. This is because an arbitrage opportunity will have opened up and it will be capitalized on until the price normalizes.
Simply put, an investor could purchase the said stock while shorting the futures contract for the stock. Since the price of the two will be somewhat similar, the investor would be able to receive all the dividends until the futures contract needs to be settled. This transaction would be completely risk-free.
So, when the company announces the dividend, investors looking to capitalize on the arbitrage opportunity will immediately start shorting futures contracts for the stock. Eventually, the price of the futures will fall to where it should be.
While this is an extreme example, the concept is the same. An increase in dividend is going to decrease the price of a futures contract while a decrease in dividend is going to increase the price of a futures contract.
What are Dividend Futures?
Dividend Futures are contracts where the buyer has a right to the dividend a stock pays for a specific price. The person who purchases the contract believes that the dividend is going to increase while the seller believes that the dividend is going to decrease.
Dividend futures are not common in the US. You can find them mostly in European or Asian markets. They are usually traded in large batches since the value of a single contract is quite small. On top of that, Dividend futures are not subject to the taxes that are levied on dividend payments.
While futures contracts do not get you a dividend, it is important for you to continuously monitor the dividend situation if you do own a futures contract. A change in dividend will affect the futures price in one way or the other.
If all this talk about dividends seems too complicated, then simply remember this: An increase in dividend means a decrease in the futures price, while a decrease in dividend means an increase in the futures price.