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a dividend based trading strategy that might be of interest

Recs

7

March 26, 2009 – Comments (4)

The strategy works like this:

1.  identify stocks that have dividend dates coming up

2.  buy shares in the stocks prior to the dividend date

3.  sell in the money calls on the same shares for the nearest dividend day.  So today you'd sell april 2009 calls.

The potential beauty of this trade is that you collect the dividend, which is taxed to a lower degree than income from a normal trade, and you can also make money on the trade itself over quite a broad range of share prices.  The sale of the in-the-money call gives you considerable shelter from losing money if the shares drop.  Lets look at some examples

XL Capital.  Imagine XL's dividend record date was next week.  To execute the trade you would

A)  buy sahres of XL, say 100 shares for the heck of it.  At close today XL shares were $6.01.  So that costs you $601 + transaction costs

B)  sell in-the-money calls on the shares you just bought (in this trade you WANT the shares to get called from you).  We'll pick the $5 strike price calls selling for $1.30. 

C)  collect the $0.10 dividend. 

Now the outcome of this trade is this:  if XL closes above $5 on april 17th, the shares will get called away from you.  Your profit will be $0.39.  $0.29 of this is normal income $0.10 is dividend income.  Your total investment was $4.71.  So thats a return of 8% or so in 1-4 weeks, which is extremely good if it can consistently be done.    If XL closes between $4.71 and $5 on april 17th you will make >>closing price - $4.71<< plus the dividend.  If XL closes at $4.61 you break even in cash, but you get a tax benefit as the dividend (profit) is taxed at a lower rate than the $0.10 loss on the trade.  If XL closes under $4.61 you will take a loss.  But, if XL closes under $4.61, all isn't lost.  You can sell another $5 call on it, lowering your basis price again, and hope that it clears $5 by the may options day.  Rinse, repeat, rinse, repeat.

 

Lets look at another company with a good dividend.  BP closed at $41.72.  The dividend is $0.84, and lets assume the dividend record date is next week.  So buy the shares as close to the record date as possible, 100 shares for $4,172.  The sell a call on those sharse thats in the money, in this case we'll select the $35 call which pays $6.80.  If BP closes above $35 on april 17th the shares will be called from you and your profit will be $0.92 ($0.84 dividend + $0.08 from the optiosn trade).  Your total investment was $34.92, so this represents about a 3% profit in 1-4 weeks. 

 

The risks intrinsic to this trade are that the stock drops well below the strike price of the call.  This risk can be mitigated by selling calls that are well in the money.  For example, sell the $2.50 call on XL or the $30 call on BP in the examples above.  That will typically be lower profit, but will be lower risk. 

I don't know what the ultimate money making potential of this strategy is, but it seems like an interesting strategy overall with some promise. 

Good luck to anybody who's long!

4 Comments – Post Your Own

#1) On March 26, 2009 at 6:45 PM, jamasony2 (< 20) wrote:

http://adamsoptions.blogspot.com/2006/11/dividend-plays.html

 

This is called a 'dividend capture' play.  Unfortunately, the big traders are already doing it, which makes it very difficult for a small trader to get in on.  You CAN get the dividend, but it requires a large enough open interest on your option relative to the volume on the day before the ex-dividend.

 To see what I mean:  go to http://www.dividend.com/ex-dividend-dates.php

and see what stocks are having an ex-date in the next day or two.  Watch the options activity during the day, and find a deep-in-the-money call.  Let's say it has 100 open interest.  If the dividend yield is decent, you might see near the end of the day 10,000 volume on that option, with only 100 open interest!

 I have actually tried this a few times, on options (either current or a month out) where there was no volume on the option near the end of the day, and in the last half hour the volume got swamped by someone else and I received none of the dividend.  I did it once also on Q and DID get all the dividends, but the bid/ask spread ate the profits. 

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#2) On March 26, 2009 at 8:39 PM, checklist34 (99.72) wrote:

hey iamasony, thanks for tha tlink that was an interesting read, and the link to dividend.com.  :)  But whats described in that link isn't what I described above, its a bit more complex and risky, with higher potential returns, than what I describe above.

I don't doubt 1000's of guys have used or contemplated the plan I said above, but I thought it was worth a mention. 

In the case i describe above the intent is to hold the stock until the option is executed, and hopefully that option is executed at the end of the month.  A risk i had'nt thought of before is the chance that the call you sold gets executed before the dividend date...  which would leave you with only the profit from the difference between strike price + premium and the share price the day you bought it. 

 

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#3) On March 28, 2009 at 1:46 PM, motleyanimal (79.87) wrote:

BP has a long history of being one of the best shareholder oriented companies in the world.

That said, there are/were closed end funds that used a dividend capture strategy. RMR Dividend Capture Fund is one, but it was focused on REITs and leveraged on top of that, so it pretty much blew up last year. I think they are reorganizing and merging all their funds together.

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#4) On January 09, 2011 at 4:06 PM, keithsan (< 20) wrote:

Interesting. at times i receive a list from http://exdividenddate.org but  haven't actually traded them yet.

as far as motley animal goes, I bought that BP after the spill and the sell off. Not a divvy play for me though.

 

 

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