Many companies offer quarterly (or more often) dividends to shareholders. This can be a great source of income and with each dividend payment received; investors are able to lower their risk in an investment. Many investors will buy a stock in part because of the dividend and the current yield. The one basic requirement to receive a dividend from a company is to be a shareholder on the day of record for the dividend.
Because stock transactions do not happen in real time and are settled three business days after an order is filled (It used to be five days), there is also a term called "ex-dividend date." The ex-dividend date is the first day that the stock is trading after eligibility for a shareholder to receive an announced dividend is past.
With the only requirement of owning shares for one overnight period it would seem pretty simple to just buy a dividend paying stock the day before it trades ex-dividend, sell the next day when it trades ex-dividend, and sit back and collect the "free" dividend from the company. The problem with a simple buy and hold overnight is the market is efficient enough to factor in the dividend. As a result a stock will often open up the next day near the previous day's close less the dividend paid.
You would be forgiven for thinking there is nothing to see and it is time to move on to the next idea. What changes the outlook is the ability to offset the change in stock price through the use of stock options. By selling an in the money call option on the stock it is possible to get past the price drop barrier. In order to use in the money options as a hedge there must be enough time premium in the option so that if you get exercised the day before the ex-dividend date you are still making enough money to make it worth your while.
Finding a needle in a stock option haystack; every week I go through upcoming ex-dividend dates and compare the dividend, yield, strike prices, trading volume, relative stock risk, and option premium to find stocks that may be good candidates for a dividend capture strategy.
I generally hold any given position for about three weeks. Now I use a few methods that produce consistent results. With the gains made, I am able to stop out and take a loss with the few that do not work out as planned. When learning a new trading strategy it is better to use a simulated trading account first.
Before entering into a dividend capture trade I check to see if any news may be upcoming during the holding period. Events like earnings, government approval results, and other potentially large share price impacting events are reasons to avoid a company. If everything is in order my first step of entering the position is to sell at or near the asking price of the hedging call option. The next step is to buy the shares of stock. I have this process automated including the asking price of the option, but this step can easily be completed manually with many stocks.
Generally after writing the covered call I just sit and wait it out. The day before a stock trades ex-dividend is a busy time for stock options to get exercised. Often the premium on options falls in front of an ex-dividend date so much that it is in the option holders financial best interest to exercise the option and collect the dividend compared to selling the option. When exercised early from the option owner I don't make as much as possible if the stock is held into the ex-dividend date, but I also free up the capital quicker and remove the risk of loss much quicker. When this happens my profit is the premium over the intrinsic value of the option (the time premium). Otherwise, I collect the dividend and put on the market the stock and option with a target profit.
As long as the stock is trading above the strike price on option expiration day, the stock gets called away and the trade is finished. In these cases I get to collect the time premium of the option on top of the dividend amount collected. If the stock is trading below the strike price I will usually exit at a loss and call it good unless I am willing to own the shares. If I am willing to own the shares I write another call option for the next front month.
Abbott Laboratories (NYSE:ABT) engages in the discovery, development, manufacture, and sale of health care products worldwide. The company was founded in 1888 and is headquartered in Abbott Park, Illinois.
Dividend Amount: $0.48
Ex-Dividend Date: January 11, 2012
The P/E ratio has come down, as the current trailing 12 months (TTM) P/E ratio is 19.6, while the forward P/E ratio is now 12.1. It appears based on the lower PE that investors are pricing in less growth. The current book value per share is 15.79.
For the same fiscal period year-over-year, revenue has improved to $35.17 billion for 2010 vs. $30.76 billion for 2009. The bottom line has falling earnings year-over-year of $4.63 billion for 2010 vs. $5.75 billion for 2009.The company's earnings before interest and taxes are falling with an EBIT year-over-year of $6.09 billion for 2010 vs. $6.24 billion for 2009.
At $56.36, the price is currently above the 200 day moving average of 52.16, and above the 60 day moving average of 54.01.
The stock has moved higher in price 4.00% in the last month, with a change from a year ago of 18.61%.
When comparing to the S&P 500, the year to date difference is -0.67%.
In combination with my buying Abbott Laboratories stock and after checking company updates, offer to sell the January $50.00 strike call for $0.13 over the intrinsic value. The option may get exercised early for a gain. In almost all cases I will sell the call option first to ensure the stock option leg is complete first. If not, after qualifying for the dividend, I will attempt to close out the trade with a gain of near $0.07.
Remember, you must buy a stock at least three business days before the record date (at least one business day before the ex-dividend date) to qualify for a dividend.
I use a proprietary blend of technical analysis, financial crowd behavior, and fundamentals in my short-term trades, and while not totally the same in longer swing trades to investments, the concepts used are similar. Nothing in the article should be considered investment advice, but you may want to use this article as a starting point of your own research with your financial planner.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ABT over the next 72 hours.