Dividend adjustments on shares and indices

A company that pays a dividend transfers cash out of the business to its shareholders. The business is worth that much less immediately afterwards, and the share price reflects it: on the morning a share begins trading without the entitlement to the coming payment, it opens lower by approximately the amount of the dividend. Nothing has gone wrong and nobody has sold. Value left the company and went to its owners.

A contract for difference reads that price and would otherwise record the drop as a market movement, crediting the side that gains from a fall and debiting the side that gains from a rise. Since a shareholder receiving the payment is compensated for the same drop and a contract holder receives nothing, the contract is adjusted in cash to leave both sides where they were. The entry is the dividend adjustment.

Which side is credited and which is debited 

The direction follows from what the price did. A position that gains when the price rises loses from the ex dividend drop, so it is credited. A position that gains when the price falls gains from the drop, so it is debited. The adjustment is the mirror of the price movement it is cancelling, and the two net to approximately nothing.

Approximately, rather than exactly, is doing real work in that sentence. The drop on the ex dividend morning is not precisely the amount of the dividend, because the market opens on whatever has happened overnight and the dividend is only one component of it. The adjustment is a fixed amount per share while the drop is whatever the market delivers, so the two do not cancel to the penny and are not intended to.

Why the two sides are not equal amounts 

Dividends are frequently subject to withholding tax in the country of the issuer, which is deducted before the payment reaches a foreign holder. A firm hedging its exposure to a share receives the dividend net of that withholding, so the credit it can pass on is net. On the other side of the book, the firm owes the full gross drop to the position that benefited from it, so the debit is gross.

The result is an asymmetry that is not a markup: the credit on one side is smaller than the debit on the other, and the difference is the withholding rather than a charge by the firm. The applicable rate depends on the issuer's jurisdiction, so it differs by instrument rather than by account, and the rate used is published alongside the adjustment.

The final row shows what the adjustment does and does not achieve. Neither side finished exactly flat, because the market's drop and the declared dividend were different numbers and because the withholding fell on one side only. The mechanism removes the bulk of a movement that is not an economic change; it does not produce an exact cancellation.

How the same mechanism reaches index contracts 

A price index is calculated from the prices of its constituents and does not add dividends back, so when a constituent goes ex dividend the index falls by that company's contribution to the total. A broad index has constituents going ex dividend on many days of the year, and in the concentrated weeks of a reporting season several can do so on the same morning.

Contracts written on a cash index therefore carry a dividend adjustment calculated as the sum of the constituent dividends weighted by their index weights, converted into index points. The adjustment on a broad index like the US 500 is made up of many small contributions; on a narrower index it is dominated by a few. Firms publish an expected schedule of index dividend points in advance, and the published figure is an estimate until the constituents have actually declared.

Two index conventions are worth separating because they behave differently. A price index, which most of the widely quoted benchmarks are, excludes dividends and therefore falls on the ex dividend day. A total return index reinvests them and does not, so a contract written on one carries no dividend adjustment at all. Germany's benchmark is the best known total return index among the majors, which is why contracts on it behave differently from contracts on price indices around a dividend season.

Contracts that carry no adjustment at all 

An index contract written on a futures contract rather than on the cash index carries no dividend adjustment, because the expected dividends are already priced into the futures contract. A futures price reflects the cash level adjusted for financing to expiry less the dividends expected before it, so the dividend has been accounted for at the moment the position was opened rather than on the day it is paid.

This is why two instruments referencing the same index can produce visibly different account entries: the cash version posts periodic dividend adjustments and finances daily, while the futures version posts neither and instead steps in price when the underlying contract is rolled. Neither is cheaper by construction. The costs arrive at different times and in different lines.

The dates that matter 

Four dates surround a dividend and only one of them affects a contract. The declaration date is when the company announces it. The ex dividend date is the first day the share trades without the entitlement, and it is the date the price drops and the adjustment is applied. The record date determines which shareholders receive it. The payment date is when the money reaches shareholders, and it can be weeks later.

For a contract, only the ex dividend date is operative, and the adjustment is applied to positions held at the daily cut off before it, on the same convention that governs financing. A position opened after the ex dividend price drop receives no adjustment because it was never exposed to the drop, which is the mechanism working correctly rather than an omission.