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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75540  
Subject: Re: Retirement, college, and Obamanomics Date: 1/1/2013 9:43 PM
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But your principal would not be guaranteed against loss

Oh, please!!
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As a general comment ... we happen to know how the insurance company effectuates this (the same basic way that these articles outline), but that doesn't matter.
In the IUL contract, there are only 2 parties, you and them. *How* they manage the investment is their concern, so these side discussions of buying options, etc. have no bearing. They could be buying Russian Yak milk futures for all we know. It doesn't matter and we don't care--they just are obligated to pay us based on the S&P500 index.

Nonetheless ...... the market pays dividends. If you own the stock you get the dividend. If you are short the stock then you have to *pay* the dividend. If you buy an option (as we assume the insurance company does) then some counterparty had to sell the option, and is therefore in a short position in the stock. Which means that they have to pay the dividend. Which they are not about to do, not going to pay out a dividend from their own pocket. They are not handing out free money. If you trace down all the details of the stock and the derivatives (the options), you'll see that if the stock pays a dividend, then all the various owners of the longs and shorts and options on aggregate receive exactly that dividend, perhaps directly, perhaps indirectly.

This is a roundabout way of saying that even though a call option doesn't explicitly pay the dividend, the dividend is taken into account in price of the option. The total return of the stock includes the dividend, and likewise the total return of the option includes the effect of the dividend. "Since whoever owns the stock as of the ex-dividend date receives the cash dividend, sellers of call options on dividend paying stocks are assumed to receive the dividends and hence the call options can get discounted by as much as the dividend amount."

IOW, when the ins. co. buys a call, they get the dividend not in cash but as a discount in the price. They get the dividend, and not you -- because IUL contracts are written to exclude dividends.
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