You must own a stock before its ex-dividend date, also called the ex-date, to get its dividend. The ex-dividend date is the first date on which a new purchase of the stock is no longer is entitled to a declared dividend. A call or put option gives you the right to buy or sell, respectively, 100 shares of a stock at a given price – the strike price -- but does not constitute ownership, so no dividend is due from option ownership. Yet, option traders are nothing if not clever. They’ve worked out techniques called “dividend arbitrage” in which a combination of options and stock can be used to capture a dividend at a profit.
On the day before ex-date, a trader using the put strategy buys shares of the dividend-paying stock and an equivalent number of put options on the same stock. The put options should be well “in-the-money,” meaning that the put strike price is well above the stock’s current price. The trader owns the stock before ex-date, so is entitled to the dividend. On the next day, which is the ex-date, the trader executes the puts, selling the shares at the strike price. The dividend will be delivered on the dividend date, and the trader is rid of the shares and the puts.
Put Strategy Example
Jane purchases 1,000 shares of XYZ Corp – which is paying a $2 dividend per share -- for $90 a share near the close of trade on April 16. She simultaneously buys 10 put contracts on XYZ Corp at a $100 strike price for $1,100 per contract. So far, Jane has spent $90,000 on stock and $11,000 on the puts, for a total of $101,000.
April 17 arrives, which is the ex-date. Jane is now qualified for a $2,000 dividend payment, which will arrive next week on the dividend date. Today, she exercises her 10 puts at their strike price of $100 each and collects $100,000. When her dividend arrives, her total proceeds will be $102,000. Since the strategy cost only $101,000, Jane walks away with a $1,000 profit.
Jane’s fiancé, Jules, prefers to capture dividends with calls. His strategy is to purchase the dividend-paying stock just before the ex-date while selling deep in-the-money call options – call options with a strike price well below the current price – and receiving a cash payment called the premium. By selling calls, Jules may have to deliver the underlying shares if the buyer executes the call; this is known as assignment. On the next day, Jules has earned the dividend. The stock experienced a $2 per share drop because it no longer trades with the dividend. The call experienced the same drop. Jules can sell the shares, buy back the calls and collect a profit.
Call Strategy Example
Jules fancies ZYX Corp stock, which is selling for $50 a share on Sept. 1 and paying a $1.50 dividend each quarter. The stock is scheduled to go ex-dividend on Sept. 2. The September call with a $40 strike price is selling on Sept. 1 for $10.20 a share. On Sept. 1, Jules buys 1,000 shares for $50,000 and sells 10 calls for $10,200, putting his total cost at $39,800.
The next day, Jules earns the $1,500 in dividends. ZYX stock opens at $48.50, down $1.50 -- the amount of the dividend, because it’s ex-date. The call options also fall $1.50 a share, to $8.70. Jules now sells the stock, collecting $48,500. He next buys back the calls for $8,700. His proceeds on Sept. 2 are $48,500 for the stock plus the $1,500 dividend, less $8,700 for buying back the calls, for a total of $40,800. Subtracting his Sept. 1 cost of $39,800 gives him a profit of $1,500.
Risk in Call Strategy
Jules took on a risk not faced by Jane. It is possible that Jack, the buyer of the 10 calls, could have exercised the calls before the end of trading on Sept. 1, the day before ex-date. If Jules is immediately assigned to deliver the shares to Jack, Jules loses the right to the dividend. This wipes out Jules’ profit.
- The Bureau of Investigative Journalism: Analysis: US Regulators Accuse RBC of ‘Massive’ Dividend Tax Scam
- The Economic Times: Traders Lose Out on Dividend Arbitrage
- A Dividend-based Arbitrage System; Daniel Staples
- Expected Return of a Call Option
- How to Calculate Stock Basis for Exercised Options
- Stock Options Explained in Plain English
- How to Hedge Futures Contracts With Options
- How Option Trading Stocks Work
- Risky Option Strategies
- Taxation of Covered Calls
- Why Don't Investors Buy Stock Just Before the Dividend Date and Then Sell?