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Dividend Capture using Covered Calls
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Dividend Capture using Covered Calls

  #1 (permalink)
Trading Apprentice
Las Vegas NV/Clark
 
Futures Experience: Intermediate
Platform: IB
Favorite Futures: Options
 
Posts: 13 since Oct 2014
Thanks: 5 given, 1 received

Dividend Capture using Covered Calls

From a site on the web I got the following strategy

Example:

"In November, XYZ company has declared that it is paying cash dividends of $1.50 on 1st December. One day before the ex-dividend date, XYZ stock is trading at $50 while a DEC 40 call option is priced at $10.20. An options trader decides to play for dividends by purchasing 100 shares of XYZ stock for $5000 and simultaneously writing a DEC 40 covered call for $1020.

On ex-dividend date, the stock price of XYZ drops by $1.50 to $48.50. Similarly, the price of the written DEC 40 call option also dropped by the same amount to $8.70.

As he had already qualified for the dividend payout, the options trader decides to exit the position by selling the long stock and buying back the call options. Selling the stock for $4850 results in a $150 loss on the long stock position while buying back the call for $870 resulted in a gain of $150 on the short option position.

As you can see, the profit and loss of both position cancels out each other. All the profit attainable from this strategy comes from the dividend payout - which is $150."

My question is simply this: Why not just sell the options, leave the stock alone, and buy them back the next day after they fall by the amount of the dividend? What am I missing?

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  #2 (permalink)
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  #3 (permalink)
Elite Member
Melbourne, Victoria, Australia
 
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TGoat View Post
From a site on the web I got the following strategy

Example:

"In November, XYZ company has declared that it is paying cash dividends of $1.50 on 1st December. One day before the ex-dividend date, XYZ stock is trading at $50 while a DEC 40 call option is priced at $10.20. An options trader decides to play for dividends by purchasing 100 shares of XYZ stock for $5000 and simultaneously writing a DEC 40 covered call for $1020.

On ex-dividend date, the stock price of XYZ drops by $1.50 to $48.50. Similarly, the price of the written DEC 40 call option also dropped by the same amount to $8.70.

As he had already qualified for the dividend payout, the options trader decides to exit the position by selling the long stock and buying back the call options. Selling the stock for $4850 results in a $150 loss on the long stock position while buying back the call for $870 resulted in a gain of $150 on the short option position.

As you can see, the profit and loss of both position cancels out each other. All the profit attainable from this strategy comes from the dividend payout - which is $150."

My question is simply this: Why not just sell the options, leave the stock alone, and buy them back the next day after they fall by the amount of the dividend? What am I missing?

What you are missing is dividends are priced into the options. Market makers set the price for the options. There are large prop firms that make all of their money based on making markets for options. It's very difficult to trade against those who set the price.

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  #4 (permalink)
Trading Apprentice
Nashville TN/USA
 
Futures Experience: Intermediate
Platform: Thinkorswim
Favorite Futures: Derivatives
 
Posts: 35 since Nov 2014
Thanks: 0 given, 32 received

Agree w/ above. Whoever wrote that strategy doesn't get it. There is no gaming or arbitrage of a dividends play. It's all figured into the price.

In fact...look at what the guy is saying....an option that is 10$ in the money selling for 10.20 only has .20 of extrinsic value left.....if you try to hold to the dividend of 1.50 your short call will be exercised and the shares will be called away by the guy who bought the calls so he can collect the dividend.

Remember...at ex-dividend any short calls that have less extrinsic value than the dividend, even by 1 penny...will be exercised.

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  #5 (permalink)
Trading Apprentice
Reno NV
 
Futures Experience: Advanced
Platform: Wedbush/Lime
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Posts: 7 since Nov 2014
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The trade is governed by the conversion arbitrage. Simply quote the synthetic and you will see that the call is trading under the put equal to the div (less fwd).


Last edited by convexxx; November 21st, 2014 at 08:57 PM.
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