How Much Do You Want To Bet On That Dividend?

by: Greg Loehr

Note: The article was written as of November 28 and references stock and option prices valid on that day.

Recently I wrote an article concerning stock dividends and I pointed out how the dividend itself doesn't make one wealthier. This upset a lot of people that believe that stocks are not devalued (by the amount of the dividend) when dividends get paid out.

So let's settle this argument once and for all. If you think you're right about something in the market, then put money on it. And if you're right, you'll make money. Any argument that arises among my trading buddies (and we argue about everything) is swiftly settled with one phrase: "How much do you wanna bet?"

If you believe that a dividend doesn't lower the price of a stock, then keep reading because I'm going to show you a trade that will guarantee you a profit. Of course you're going to have to be comfortable with the fact you're betting that the entire options market is wrong, and all of the Ph.D.'s at Goldman Sachs have yet to pick up on this free money.

**Spoiler Alert** Don't read this paragraph if you think you can make money from the dividend. Because if you place the trade I'm about to describe, you will lose money.

Tomorrow Blackrock, Inc. (NYSE:BLK) goes ex-dividend in the amount of $1.50, and the stock is currently trading at $195.25 (as of this writing). If you buy the December 195 calls, and simultaneously sell the December 195 puts, then you've purchased something called a "combo" and this option trade is going to act just like a long stock position priced at $195.

So here's the "good news": you can receive an 80-cent credit to do this! This means you're effectively buying BLK stock at $194.20 when it's currently trading at $195.25. To lock in your profit you just need to sell short the actual stock at $195.25. All of these prices are going to change throughout the day as the stock moves, but pretty much the same relationship is going to exist through the end of trading today.

By engaging in the above trade, which you shouldn't do, you're actually locking in a loss. Yes, you have a $1.05 profit by buying stock synthetically lower and selling the real shares at a higher price. But by shorting the stock you're going to have to pay out the $1.50 dividend, and that completes a loss of $0.45, plus commissions.

Why would the options market price BLK stock lower today than where it is currently trading? Because, regardless of where the stock trades tomorrow, it's going to be lower by $1.50 than if the dividend had not been paid. This relationship of pricing future stock prices lower by the dividend has to be maintained, even as the stock moves around, to avoid an arbitrage setting up.

The natural inclination now is to say "Well, if I would lose money making that trade, then I should be able to make money by doing the opposite trade, right?" Wrong. The option market has fairly priced the future value of the stock lower by the amount of the dividend, and if you place the opposite trade you're still going to lose because of the slippage and commissions.

I knew my first article would make some people quite angry. Why? Because I've had this same dividend conversation with people in many of the United States, as well as Ireland, England, Dubai, Canada and Australia. And I received an avalanche of scathing comments about that article, but I expected such a reaction.

One comment did, however, catch my attention. It was something like "people just write articles to take the other side of some issue and argue."

This brings up a great point. I didn't write the article just to cause an argument. I wrote the article because many investors erroneously believe the dividend to represent free money, or that a dividend yield actually guarantees a return of the stated yield.

Of course, a stock with a quoted yield only actually returns that quoted yield if the stock goes up in value by the amount it loses from paying out the dividend. For example, investors are still waiting for many of the Citigroup (NYSE:C) quoted dividend yields to arrive.

Many of the negative comments about my dividend article actually moved off topic and concerned whether dividend-paying stocks are better, or if tax implications matter, or the impact of re-investing dividends. There are always going to be trading ideas such as these that people are going to argue about because there is no definitive answer.

Is AAPL a good stock? You can argue about that all you want. If you think you're right, then either way (long or short) put some money into and see what happens. But does a dividend payment make you money? No. It's a mathematically defined transaction.

You don't really need to take my word for it. The market will decide for you whether you're right and will reward you with money if you are. If you're wrong, you'll lose money. It's usually only in this latter fashion that people finally start to learn.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.