ETFs should come with warning labels. Don't treat options on ETFs as if they're cheap proxies for options on the indices the ETFs track.
ETFs or exchange-traded funds differ in several important ways from the indices they might track. One important difference lies in the preferential tax treatment that options on broad-based indices receive. As far as I know, options on ETFs don't receive the same preferential treatment.
Another important difference will be the focus of this article: dividends. Broad-based cash-settled indices don't offer them. Many ETFs do. And they do it in a way that sometimes causes maximum angst to options traders.
Some ETFs go ex-dividend during option-expiration week. An Internet search with the phrase "dividends on ETF during expiration" will turn up a number of sites that warn of the sneaky--or snarky?--practice some ETF funds have of paying dividends on expiration Friday. That makes their ex-dividend day, the day by which you must own the ETF to collect the dividend, during option-expiration week, too. Some don't preannounce the amount of their dividends, either. It's usually possible to figure out whether a sold call is likely to be exercised by comparing the amount of time premium remaining to the size of the dividend, but if one doesn't know the size of the dividend, that's not possible.
What else happens during option expiration week? The extrinsic value or "time premium" in options shrinks. Options that are in the money, particularly options on non-volatile entities, may have very little extrinsic or time premium left by option expiration week.
This can cause particular trouble for options traders who have sold calls on an ETF as part of a combination or complex option strategy. Have you ever heard that the only risk in a butterfly trade or a bull call debit spread is the money you spent to establish those trades? That's not entirely true when you have a call butterfly or bull call debit spread. If the sold calls that make up part of that trade are in the money on ex-dividend day and if there's very little time premium left, you may find that those calls have been exercised and you owe someone stock and a dividend on that stock.
I've been there and done that, with a cheap speculative SPY butterfly that I was letting run, thinking markets were due for a pullback and forgetting that the SPY was about to go ex-dividend. I'm not the only person to whom that's happened, either. Some traders in the DIA, the ETF that tracks the Dow, have been similarly surprised, as the DIA goes ex-dividend every month.
This article speaks to a tenet that all options traders should keep in mind: know what's going on with the underlying you're trading. In addition to knowing whether a stock or ETF is about to go ex-dividend, you can extend the "what you need to know list" for equities. I run into lots of traders who are always scanning for optionable equities that fit certain parameters. If the chart looks right and the options are liquid enough, traders might then leap into a trade on that underlying, but any options trader should first check for earnings, dividends, and even important upcoming company events for either that underlying's company or that of its competitors. Have you ever been trading AMD or INTC options when the other company makes an announcement about a new development that will impact its competitor's products?
For equities, Yahoo Finance often provides ex-dividend dates. I've found it more difficult to search for ex-dividend dates on ETFs, but Yahoo Finance does list the exchange and the issuer. Going to the website of the issuer of the ETF is sometimes necessary to puzzle out the information. For example, this State Street Global page provides, on the lower left-hand side of the page, a pdf file on ETF dividends. The pdf lists recent ex-dividend dates for many of its ETF's, including the DIA and SPY and includes a 2009 schedule. The next ex-dividend dates listed for the DIA at the time this article was first roughed out were 9/18/09 and 10/16/09, both on expiration Friday's, of course.
The best advice is to know something about the underlying on which you're trading options. A cheap OTM butterfly on a cash-settled index that ended up in the money wouldn't have resulted in my needing to pay a dividend to somebody. That cheap butterfly on the SPY did.