In trying to capture dividends there is no free lunch. In fact, since Wall street is involved, the best you can hope for is an affordable lunch. I have looked at, and tried quite a few approaches—most of which don’t work, but I have found one approach that does work with some ETFs. Ironically you don’t actually collect the dividend most of the time, but you can collect an amount similar to the dividend-with a reasonable amount of risk.
Anyone with money can capture a dividend—you buy the stock (or ETF) before the ex-dividend date and hold it until the ex-dividend date. The challenge is to close out your position with a profit that is worth the risk. Typically the stock will drop by about the dividend amount when it starts trading on the ex-dividend day, but if the stock has a generally up day your overall profit can be better than the dividend. You lose money if the stock drops by more than the dividend amount (ignoring commissions)—and if the market goes bad you can lose many months worth of dividends in a hurry.
There are two ways to deal with this kind of risk, you can try to predict the future, or you can hedge. If you are any good at predicting the future then you don’t need to be messing around with dividends, you should just be buying and selling based on your predictions. With hedging you try to reduce, or better yet eliminate your risk by also investing in something that moves in the opposite direction of the stock so that the price movements cancel out. Some high quality hedges for a stock or ETF:
- Sell the stock short
- Sell a stock short that very closely tracks the stock you own (e.g., IVV for SPY)
- Buy an ETF that has an inverse relationship to your stock (this can be done in IRAs, they don’t allow shorting)
Hedges that can reduce your risk, but only provide medium protection include:
- Shorting the general market or industry sector that your stock is in
- Buying inverse ETFs for the general market or industry sector
- Use stock options with strike prices close to the current market price
- Use stock futures (sell futures)
The folks on Wall Street aren’t about to let you get away with any sort of risk free profit, even if it is only a few tenths of a percent. The high quality hedges above don’t work at all (see
here) for dividend capture. The medium level hedges don’t eliminate the downside risk and introduce the possibility that an upside move by your stock might be more than wiped out by an even stronger downside move by your hedge.
I have used one approach that offers a reasonable payoff, with reasonable risk—using deep-in-the-money stock option calls to capture the dividend amount. More about this in this post.
