The act of trading in and out of stocks on their ex-dividend dates sounds simple in theory, but in practice, can be a little more tricky. The market makers for any given stock will usually adjust the stock's trading price on the ex-dividend date. The stock's price is reduced by the exact amount of the dividend at the open of the market. From there, the stock price could rise or fall, but generally, this practice will offset the gains received from dividends.
One way to hedge against the immediate drop in the common stock price is to sell call options against your shares. Depending on the price of the stock, the bid price of the option, and the strike price of the call, there are many ways to make this trade.
Currently, ConocoPhillips (COP) and Sasol Ltd. (SSL) present an opportunity to trade ex-dividend dates with covered calls. Each of these stocks has a dividend yield over 4%, which is more than double the yield of a ten-year Treasury bond. Each also trades with a forward P/E ratio less than ten, giving them high earnings yields.
ConocoPhillips stock goes ex-dividend on October 11th, meaning that holders of the stock shares on that day will receive the dividend of $0.66 per share. Before the ex-dividend date, holders of the stock should consider selling the $57.50 strike price October 2012 call option for $0.46. On the ex-dividend date, the stock may open below the strike price, but selling the call option helps to lock in some of the profit from the dividend. There is a chance that the trade could end with a profit of 1.7% profit over the 12 day period (50.35% annualized) and the break-even price is $56.54.
Sasol Ltd. goes ex-dividend on October 10th and shareholders will be entitled to a dividend of $1.4409 per share. Investors could consider selling the November 2012 $45 strike price call option for a premium of $0.95. These options are currently out-of-the-money, but will offset a large portion of the drop in share prices on the ex-dividend date. If shares remain unchanged at the expiration date of the option, the trade yields a 5.5% return over the next 40 days, or 49.4% annualized. The break-even price on this trade is $41.40.
The calculations provided above were generated using an online calculator provided by the Options Industry Council. Options prices and stock prices were taken from the closing prices on Monday,October 8th.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.