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SPY dividend capture–June 2010

Wednesday, June 16th, 2010

I bought SPY at 111.64, and sold-to-open SPY 108 June-30 expiration calls at 4.08 for a net investment (debit) of  107.58.     I used the quarterly SPY options because I could go considerably deeper in the money with the calls and still get a premium that is close to the likely SPY dividend for this quarter  (around $0.50).   Schwab does not appear to offer access to this series of  options, but Fidelity does.

If SPY stays above 111 through this Thursday I expect these options will be assigned–because the premium left on the calls will be less than the dividend the stock will payout.   Friday is the ex-dividend date for SPY.   If the calls are assigned I’ll collect $0.42 per share.     If the options are not assigned, I will collect the SPY dividend–lowering my breakeven point to around 107.08.

For more info on this dividend capture strategy see this post

Posted in Advanced Topics, Covered Calls, Dividend Capture, Options, all | View Comments

Capturing dividends with covered calls—are you ready?

Tuesday, April 6th, 2010

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.

Posted in Advanced Topics, Covered Calls, Dividend Capture, Options, all, dividend, ex-dividend | View Comments

Dividend Capture Strategies

Saturday, April 3rd, 2010

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:

  1. Sell the stock short
  2. Sell a stock short that very closely tracks the stock you own (e.g., IVV for SPY)
  3. 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:

  1. Shorting the general market or industry sector that your stock is in
  2. Buying inverse ETFs for the general market or industry sector
  3. Use stock options with strike prices close to the current market price
  4. 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 my next post.

Posted in Advanced Topics, Covered Calls, Dividend Capture, Mainstream, Options, all, dividend, ex-dividend | View Comments

SPY dividend capture strategies that don’t work…

Wednesday, March 17th, 2010

Some SPY dividend capture strategies I don’t recommend:

1. Sell SPY short right before closing the day before ex-dividend

  • Rationale:  Securities tend to drop by about the dividend amount when trading begins (pre-open trading)
  • Problem:   The buyer that bought the stock from you deserves the dividend and the loaner that loaned you the stock you sold (probably unknowingly), deserves the dividend too.  Two dividends, one share of stock–you make up the difference.  You will have the dividend amount subtracted from your account.

2.  Create a covered call position with SPY right before ex-dividend by buying SPY and selling  deep in the money calls

  • Rationale:  You own the stock, so you will collect the dividend.  The value of the short calls moves in direct opposition to the value of SPY, so you have a near perfect hedge, with very little risk from anything other than a total market meltdown.   The options expire the next day after the ex-dividend date so the position automatically closes itself out the weekend after the ex-dividend.
  • Problem:  If the premium value of the SPY calls is significantly lower than the dividend amount (which is a certainty with deep in the money calls near expiration) your calls will very likely  be assigned.  Your stock will be called away, and you will not collect the dividend.  Unless you received some premium when you created your covered call position (if your breakeven price is  less than the strike price)   you have just paid commissions for nothing.

3.  Buy SPY and sell the same number of IVV (the iShares version of SPY) short

  • Rationale:  Since IVV goes ex-dividend a few days after SPY there is time to buy back IVV before its dividend is due.  SPY and IVV both track the S&P index, pretty much exactly, so the long and short position are perfectly hedged.
  • Problem: The value of IVV jumps by the value of the SPY dividend on the SPY ex-dividend date.  That offset continues until IVV declares its dividend.  At that point the two ETFs go back to tracking each other with IVV typically being  ~$0.40 higher.   Your losses in your short IVV position cancel out your dividend gains from holding SPY.  Only your broker is happy.

Posted in Covered Calls, Dividend Capture, Mainstream, Options, all, dividend, ex-dividend | View Comments

Dividend capture strategies—three approaches to skip

Wednesday, March 3rd, 2010

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.

  1. 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.
      .
  2. 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.
      .
  3. 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.

Posted in Covered Calls, Dividend Capture, Mainstream, Options, all, dividend, ex-dividend | View Comments

Feb 2010 DIA dividend capture

Friday, February 12th, 2010

Bought DIA at 101.17, sold-to-open Feb 99 calls at 2.44 — both with market orders, for a net debit of 98.73.    Pretty frustrating morning– tried to do buy-writes first thing today with a net debit amount, but I  never got a fill, even though I was splitting the ask/bid price or slightly more generous on the options (97 calls at that point).  I don’t know if this is due to the upcoming DIA dividend, the general behavior of the DIA option market makers, Fidelity’s software/order flow, or what.

For this strategy, getting better than the listed ask/bid price is pretty important– $0.05 or $0.10 is a pretty big percentage of the available profit for the deep ITM calls.  I looked at doing a call vertical spread,splitting the bid/ask spread,  with the long side way OTM (e.g., 108)–to be followed by buying DIA at market.   The spread might execute better because it would be be an options only trade, and would only cost a cent or two, but by that time the market was rallying strongly–I didn’t want to be in an effective naked short call situation in a dynamic market while I created the long side of the DIA covered call position.

Posted in Advanced Topics, Covered Calls, Dividend Capture, Options, all, dividend, ex-dividend | View Comments

DIA dividend capture

Friday, February 12th, 2010

The SPDR Dow Diamond ETF is an interesting candidate for a dividend capture strategy–if you can do it in a tax sheltered account such as a traditional or ROTH IRA.   On an annual basis is it yielding around 2% and it distributes dividends monthly.  Its dividend payouts are not consistent month to month, they vary from an average of  $0.11 in January over the last 5 years, to and average of $0.33 in October.  The chart below gives details.   February’s average payout is around $0.25, which is pretty close to a .25% return since the DIA is around $100 per share right now.

DIA is unusual for a index ETF offering monthly dividends, in that its ex-dividend dates are the day before the option expiration date for that month.  For example DIA goes ex-dividend on 19-February and the last day of trading on the options is also the 19th with expiration on Saturday the 20th.

This arrangement sets up a straightforward dividend capture scheme using covered calls.   You buy DIA and sell DIA ITM calls, with an extrinsic  value (time value) of approximately the dividend value (historically about 0.25 for February).  At closing today, with DIA at $101.5, this would suggest the 98 Feb call, which at $3.75 would give the target extrinsic value.  The break-even point on this position will probably be 101.5-3.75 =97.75.  I say probably, because there is uncertainty on whether you collect the 0.25 per share dividend or not.

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Posted in Advanced Topics, Covered Calls, Dividend Capture, Mainstream, Options, all, dividend, ex-dividend | View Comments


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