How To Collect Dividends Without A Loss In Share Price

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 |  Includes: DUK, HCP, NGG, NLY, NVS, SCCO, T
by: Kevin Quon

The problem with dividend-paying companies is that they are very inefficient at returning any capital gains appreciation when it comes to the stock price. When a dividend is declared, the share price drops a similar amount of value on the ex-dividend date as the corresponding amount of value has left the company. What results is a very static looking chart often typified by deep one-day cuts, and a stock price that trades relatively within a set range. The following chart for Annaly Capital Management (NYSE:NLY) gives a sense of what this looks like.

A simple options strategy can offer a significant advantage for those who understand how the concept works. For investors looking to beat the market regardless of the direction, a simple put option strategy might serve as an excellent method of entering a position. Yet when it comes to collecting a "free" dividend, however, the mere use of a covered call strategy can essentially allow for both the collection of the dividend without the inevitable loss on the share price. The following example describes how this works in theory (ignoring commissions for the ease of explanation):

Scenario:

  • Corporation 123 has declared that it is paying a cash dividend for $2.50 in late December. One day before the ex-dividend date, John buys 100 shares of Corporation 123, which is trading for $120.00 share. He spends $12,000 At the same time, John also writes one JAN100 call option priced at $21.00 for a total of $2,100.

Results:

  • On the ex-dividend date, the stock price of Corporation 123 drops by $2.50 to $117.50, a value of $11,750. Similarily, the price of the written JAN10 call drops by the same amount to $18.50, a value of $1,850.

  • As John had already qualified for the dividend, he decides to exit the position by selling the 100 shares of Corporation 123 and buy back the written call options at the above mentioned prices.

  • Selling the stock resulted in a loss of $250. Buying back the call options resulted in a gain of $250. The profit and the loss from the transactions thereby nullify each other (excluding commission costs). The resulting profit from the entire scenario is the captured dividend, which is $250.

The risk involved in this trade lies entirely on the assumption that no assignment of the covered calls takes place. If assignment takes place prior to the ex-dividend date, John would not have been able to qualify for the dividends.

This strategy only works when the call strike price plus the premiums received are greater than the current stock price. This is to prevent inevitable assignment of the call option were this not the case. Using a deep in-the-money call option is ideal in order to ensure the same drop in share price, as such calls have a delta of nearly 1. Using at-the-money or out-of-money calls will increase the likeliness of not having an assignment. However, such calls will come at a cost of not experiencing the full drop of the call price that corresponds to the share price drop.

Collecting these "free" dividends can also be an ideal way of capturing the company payout while still participating in the recovery of the share price before the next dividend payment as one normally does. In essence, instead of selling the stock, but holding onto it and just trading the covering call option, these otherwise static companies can essentially have doubled payouts by collecting the call gains along with the dividends. This double dividend strategy works well on a diversified high-yield portfolio where capital is already parked for income purposes.

While this dividend collection strategy works on almost any dividend-paying company when put into proportion, investors would fair better to perform this strategy on high yield companies with larger market capitalizations to ensure the necessary volume for trading purposes. Companies that pay dividends on a monthly basis should also be avoided as the dividend will often be too small to make a considerable impact. The following sample list of companies may be ideal candidates for investors looking to collect these "free" dividends. All values were taken as of January 22, 2012:

Name Market Capitalization Last Price Trailing Div% Dividend Cycle
Novartis AG (NYSE:NVS) $133.3 B $55.11 4.3% Annual
AT&T (NYSE:T) $180.8 B $30.51 5.7% Quarterly
HCP, Inc (NYSE:HCP) $16.7 B $40.85 4.7% Quarterly
National Grid plc (NYSE:NGG) $34.5 B $48.41 6.2% Bi-Annual
Duke Energy (NYSE:DUK) $28.4 B $21.30 4.7% Quarterly
Southern Copper (NYSE:SCCO) $29.6 B $35.14 7% Quarterly
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.