In a recent post I gave an overview of dividend capture strategies.
In some situations an effective way to hedge risk with a dividend capture strategy is to use covered call options. If you are not familiar with options this might sound exotic, but it’s truly the training wheels of option trading. With covered calls you can introduce yourself to the conservative, hedging possibilities of options while increasing your odds of making modest amounts of money. Before getting into the details, please review the checklist below, to see if you are ready / able to do this:
- Do you have enough capital?
- This strategy requires you to buy hundreds of shares of stock to make it worth your trouble, do you have the money?
- You can use margin to buy the stock, but that will increase your costs.
- Will you be content with a small gain?
- This strategy is generally not effective with stocks with large dividends (e.g. 4% or higher). It works better with stocks that offer annualized dividends in the 2% to 3% range
- On the good news side, you generally get the small gain with less than 10 business days of investment
- Does the stock/ETF you want to capture the dividend on have a active option market?
- If the options are thinly traded, or if appropriate strike prices are not available this strategy does not work
- Are you set up for at least the first level (simplest level) of options trading in your brokerage account?
- If your account is not an IRA then you will need to have a margin account. Don’t worry, there are no interest charges or chance of a margin call with this strategy (assuming you don’t buy the stock on margin)
- This first level of option authorization usually allows covered calls and simple purchases / sales of puts and calls
- Typically you can do these sorts of trades in a Roth / Traditional IRA — however you do need to apply for that capability if you don’t have it already
- Are you willing to learn about combo orders? These are orders that simultaneously fill your stock and options orders at a not-to-exceed price
- These orders are prudent to use in fast moving markets, and when bid/ask prices are widely separated
- Combo orders are not necessary if bid/ask spreads are small and if you are willing to do fast sequential market orders
Extra Credit
- Can you make your investment in an IRA account?
- If so, this dividend strategy is more attractive, because you can defer taxes on any gains
Pass the test? In my next post I’ll give some screening criteria for good positions and the basic setup of this dividend capture strategy.
View Comments
Comment by Brian — April 8, 2010 @ 11:38 pm
The January 27, 2010 State Of The Union Speech outlined that 1.5 million new jobs will be created in 2010 and that job creation is the Democrats number one priority in 2010. The U.S. exports are projected to double in five years and add another two million jobs over this time frame. The U.S. financial system was on the “verge of collapse” when President Obama took office and positive GDP numbers and a 78% increase in the S&P 500 index transpired since the March 2009 lows. Unemployment benefits were extended or increased for more than eighteen million Americans, health insurance was made less expensive for 65% of families who get their coverage through COBRA and twenty-five difference tax cuts were passed. Ninety-five percent of working families experienced tax cuts. Taxes were also cut for first-time homebuyers, for eight million Americans paying for college and for parents trying to care for their children. Two million Americans are working due to the steps that the Democrats took. These include over 200000 in construction and energy, 300000 teachers and tens of thousands of police officers, firefighters, correctional officers and first responders. Community banks will be giving small businesses over $30 billion in new loans and a new business tax credit will be implemented. A $10000 tax credit for four years of college, a near doubling of the child tax credit and an expansion of the tax credit to establish a nest egg will be implemented. Obesity in the U.S. is being challenged and government spending will be frozen for three years starting in 2011. Based on these and other positive economic reports that have been released since the time of the January 27th State Of The Union Address, it is not surprising that investors are not apprehensive about investing in the U.S. stock market. A S&P 500 index level of 1250 and a VIX reading below sixteen may occur by May. The major U.S. stock market indexes are displaying a Yes we can, yes we can, yes we can attitude to the ability of the bullish stock market conditions to continue.
Writing out-of-the money put options on stocks and/or E.T.F.’s (as compared to writing covered call options) may be a more profitable strategy to implement once a minor correction in the major U.S. stock markets occur.
Comment by Brian — April 8, 2010 @ 5:38 pm
The January 27, 2010 State Of The Union Speech outlined that 1.5 million new jobs will be created in 2010 and that job creation is the Democrats number one priority in 2010. The U.S. exports are projected to double in five years and add another two million jobs over this time frame. The U.S. financial system was on the “verge of collapse” when President Obama took office and positive GDP numbers and a 78% increase in the S&P 500 index transpired since the March 2009 lows. Unemployment benefits were extended or increased for more than eighteen million Americans, health insurance was made less expensive for 65% of families who get their coverage through COBRA and twenty-five difference tax cuts were passed. Ninety-five percent of working families experienced tax cuts. Taxes were also cut for first-time homebuyers, for eight million Americans paying for college and for parents trying to care for their children. Two million Americans are working due to the steps that the Democrats took. These include over 200000 in construction and energy, 300000 teachers and tens of thousands of police officers, firefighters, correctional officers and first responders. Community banks will be giving small businesses over $30 billion in new loans and a new business tax credit will be implemented. A $10000 tax credit for four years of college, a near doubling of the child tax credit and an expansion of the tax credit to establish a nest egg will be implemented. Obesity in the U.S. is being challenged and government spending will be frozen for three years starting in 2011. Based on these and other positive economic reports that have been released since the time of the January 27th State Of The Union Address, it is not surprising that investors are not apprehensive about investing in the U.S. stock market. A S&P 500 index level of 1250 and a VIX reading below sixteen may occur by May. The major U.S. stock market indexes are displaying a Yes we can, yes we can, yes we can attitude to the ability of the bullish stock market conditions to continue.
Writing out-of-the money put options on stocks and/or E.T.F.'s (as compared to writing covered call options) may be a more profitable strategy to implement once a minor correction in the major U.S. stock markets occur.
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