I have been not so patiently waiting for the market to pick a direction. I have been surprised at the strength of the rebound from the lows a month ago–we are less than a point away from SPY setting 15 month highs. My gut is still telling me we are in a trading range similar to 2004 and 1999 after big bull run-ups, but I’m not willing to put a lot of chips down to back that up. I’m still about 80% in cash, with my bearish SDS play somewhat in the red. Oil looks high, and I’m not anxious to try and capture the upcoming March SPY dividend because of what feels like downside risk.
Over the last year I have not tried to strongly play the downside moves, but I wondering if I should be, for example going long on VIX options, or shorting SPY in some fashion. The upside odds look quite a bit lower than the downside odds right now.
The dividend capture approaches that I describe below do work some of the time. My experience is that they expose the investor to excessive risk relative to the payoff–or they don’t pay off often enough.
Buy and hold dividend paying stocks
If you love the stock, this is a fine strategy, but then it really isn’t a dividend capture strategy. The dividend is just a bonus. If you don’t particularly like the stock, or don’t know much about the company / index then the price risk you assume typically swamps out the dividend.
An advantage of this approach is that if you hold the stock long enough then you qualify for qualified dividends which currently have a lower tax rate. I prefer to do dividend capture in tax deferred accounts so the small gains aren’t ravaged by taxes. .
Buy the day before ex-dividend and sell at closing
Many dividend paying stocks do have a run-up the day before ex-dividend, but market risk makes this an iffy proposition.
If the stock tanks due to market action it is tempting to not sell and at least collect the dividend, but this is often a bad idea. The stock will typically drop the amount of the dividend at opening regardless of the market conditions and if the day before was bad, the momentum is clearly negative. Investors that don’t follow the ex-dividend dates might conclude the stock is continuing to weaken and bail out. .
Buy the stock a few days before ex-dividend and sell deep in the money calls options on the stock—hoping they won’t be exercised.
This would be a fine strategy if the options market makers were stupid. Clearly they are not. Usually a few days before ex-dividend the premium available on the deep ITM calls drops to near zero, and they will almost certainly be exercised the night before the stock goes ex-dividend—leaving you with nothing.
It is tempting to sell not-so-deep ITM options to get some premium up front. If the option expiration date is not close to the ex-dividend date this is generally a bad idea. If the premium is attractive then you typically are not very deep in the money—exposing you to market risk. Unless the underlying moves strongly up your options will probably not be assigned and then you will see a nasty jump in option premium starting at opening on the ex-dividend date—making it unprofitable to close out the position until near the option expiration date.
The surprising date / value / normalized volume correlation on the S&P 500 between 2004 and 2010 continues, with the 3rd of March SPY closings only differing by 3%. If 2010 continues to track 2004 then we should see an ongoing ramp in trading volume, with a 30 day moving average of around 300 million shares per day on SPY, compared to the current run rate of about 220 million. After spiking up to almost 500 million shares on the recent bottom on Feb 9th things have quieted down. People are understandably nervous, with only the most optimistic forecasting a continued strong bull market.
My gut is telling me that we are approaching the 2010 top trend line–but the bulls are in control right now, at least until tomorrow…
I continue to scan for ways to profit on what I believe will be the inevitable rise of interest rates in the future. I think the classic 30 to 40% weighting in bonds that financial advisers propose for balanced risk, moderate growth portfolios is going to be a big loser in the next couple of years.
This Bloomberg webpage has a daily graphical update of the US government bills/bongs yield curve, plus going rates on TIPS, Corporates, Municipals, etc.
This page on Smartmoney.com gives a tutorial on the yield curves, allowing you to compare today’s yield curve against historic ones, and showing the various shapes the curve can take.
This article (”Duration–the looming scandal“) on bonds, illustrates how the duration of a bond or collections of bonds can be used to easily estimate the principal value impact of interest rate changes.
Did covered calls on SDS (double short S&P 500). Bought SDS at 35.86, sold March 34 calls at 2.37 for a net investment of 33.52. Extrinsic value is .48, so the max profit potential is .48/33.52 = 1.4%
Oil (EFT USO) — I’m bearish right now at 38. I will probably jump back in with covered calls if it drops to the 36 range. .
SPY — I’m bearish now. Will probably jump back in with covered calls if SPY drops to around 106. .
Monday March 1 – Ex-dividend date for most ETFs with monthly distributions (e.g., AGG, IEF, JNK, TIP). I’m still looking for a good dividend capture play here. Most of these funds have thinly traded options and low volatilities, so option based dividend capture schemes I’ve priced are not attractive. Best strategy I’ve seen is buying the ETF the morning before ex-dividend and selling at close that day–but this is obviously exposed to market action. JNK could probably be hedged by going short on SPY (or long SH, SDS) , but probably not a good enough correlation to make me comfortable. Purchases have to be made by Friday February 26th to qualify for the dividend. .
Wednesday March 17th — VIX option expiration. Currently the VIX index is running in the low twenties. I don’t have any feel for direction right now–staying on the sidelines, awaiting inspiration. .
Friday March 19th — Ex-dividend date for DIA. My February dividend capture approach worked well–will have to see how the market is behaving 4 or 5 days before. My dividend history chart suggests the payout will be around $0.24. .
Friday March 19th — SPY ex-dividend (estimated payout of $0.52) date–also ex-dividend date for many SPDRs funds with quarterly distributions. Schwab’s new no commission ETFs will probably go ex-dividend on the 19th also. I will probably use the same dividend capture / early option exercise approach I used on DIA (sell ITM calls 4 or 5 days before the ex-dividend with extrinsic values about equal to the the dividend payout). It works very well in a flat or uptrending market. I typically use both the monthy SPY options and the quarterly SPY options, which expire 31-March (symbol RDQ). The dividend payout gives an additional ~$0.5 margin on break-even if the market goes against you. .
Saturday March 20th — Equity options expire .
Thursday March 25th – IVV ex-dividend (estimated payout of $0.50) date–also ex-dividend date for many iShare funds with quarterly distributions. IVV’s options historically have not been attractive for my ITM option dividend capture approach, so I usually sit out this one. Still looking for a good candidate however. .
Thursday April 1st – SPY March quarterly options expire
SPDR website link for latest ex-dividend and pay date information (look for “ETF dividends” link). Includes ETFs tracking Barclays, ,Diamond, Dow Jones, Morgan Stanley, MSCI, KBW, Russell, S&P, and other indexes.
iShares website link for latest ex-dividend and pay date information (look for “Distribution Schedule (2010)” on right side). Includes ETFs tracking iBoxx, Barclays, JP Morgan, Dow Jones, Morningstar, S&P, Russell, MSCI, and other indexes. Snapshots from their website:
My USO position and my remaining SPY covered call positions were called this weekend, so I’m back to about 90% cash. Despite the scary stuff in the last couple of weeks, they ended up yielding their maximum profit potential.
Oil looks expensive right now, so I wouldn’t be surprised to see a pull back there. The S&P 500 could certainly go higher with this rally, but looking at the 250 day chart the resistance level at 111 really stands out. This one could be tough to break through. Click chart to enlarge.
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