Your stock is behaving erratically and you have no clue why. You made sure to avoid the earnings report. It does not report same store monthly retail sales. The technical indicators meet the system criteria. You check the recent news posted for this equity and nothing turns up. Despite having done your due diligence, the recent chart pattern looks like a roller coaster, and volume is way up. Did this ever happen to you? What could possibly be causing this? One possibility is that your stock has fallen victim to the dividend capture strategy.
Definition:
The dividend capture trading strategy is the act of buying a security for its dividend, capturing the dividend, and then selling the stock to buy another stock which is about to pay a dividend.
Key dates associated with stock dividends:
- Dividend Declaration Date: The date on which dividends are declared by the board of directors.
- Ex-Dividend Date: Ex-dividend means “without dividend.” Practically speaking, the ex-dividend date is the first day that the stock trades without the right to receive the current dividend that is announced by the company. On this day, the price of the stock (as of the last trade in the previous trading session) usually will be reduced by the amount of the dividend. To capture the dividend, you must purchase the stock BEFORE the ex-dividend date. If you purchase an equity one day before the ex-dividend date, and then sell the stock on the ex-dividend date, you are entitled to receive the dividend. If you purchase the stock on or after the ex-dividend date, you will not be on the company’s books and records as owner of the shares, and thus will not be entitled to collect the current dividend.
- Record Date: The date established by an issuer of a security for the purpose of determining the holders who are entitled to receive a dividend or distribution. Essentially, the record date is a cut-off date set by the company that allows it to determine which stockholders qualify to receive the declared dividend. All investors who are official stockholders as of the record date are entitled to receive the declared dividend on the payment date. Dividend eligibility is automatic for shares purchased prior to the ex-dividend date.
- Payment Date: The date on which the dividends are deposited into your investment accounts or sent in the mail.
How to utilize the dividend capture strategy:
Investors start purchasing a stock after the declaration date but before the ex-dividend date. Once the dividend is captured, the stock is held for 61 days so that the profit is taxed at a reduced 15% rate. If the shares are sold prior to 61 holding days, dividends will be taxed as ordinary income up to 35%. After the 61-day holding period, the stock is sold and the cash is diverted to another security about to go ex-dividend.
Receive 6 dividend payments rather than 4:
Most companies pay dividends on a quarterly basis, so an investor who holds a particular stock for a year ordinarily will receive four dividend payments that year as owner of the stock. However, if we use the dividend capture strategy and assume a 61-day holding period, an investor would then generate six annual payments (365/61 = 6).
Problems with the dividend capture strategy:
- There is no guarantee that the stock price won’t fall more than the amount of the dividend.
- This strategy requires you to hold the stock for 61 days after capturing the dividend in order to avoid the higher tax rate.
- The share price will go up before the ex-dividend date, and subsequently depreciate thereafter by, at least, the amount of the dividend. New buyers will not benefit from the dividend, a fact that tends to work against share appreciation. This may result in a higher buy price and lower sell price.
- Trading commissions and buy-sell spreads need to be overcome to make a profit.
Institutional investors play the dividend capture game in a different ballpark:
That’s right….we play in the corner schoolyard, and the institutional investors play at Yankee Stadium. Market makers, sophisticated firms with good clearing relationships, and well-capitalized upstairs trading firms have virtually no transaction costs. As a matter of fact, many exchanges have instituted cap fees (i.e. a maximum ceiling on fees) that can be charged to these players to encourage them to participate in such a strategy and others. The big boys can now take a $0.31 dividend (for example), parlay that with hundreds of thousands of shares and negligible transaction costs, and make a nice profit. These institutional players also use a sophisticated options strategy to buy the shares at a lower price. By purchasing shares at a lower price and eliminating the bulk of the transaction costs, they have a much greater opportunity to succeed using the dividend capture strategy than the average Blue Collar Investor. That said, I do think that it is possible to succeed with this strategy in most bull market scenarios.
How the dividend capture strategy may impact our stock positions:
Because the institutional investors engage in this strategy by buying and selling hundreds of thousands of shares, the shares will rise in value prior to the ex-dividend date, and will decrease in value after the ex-dividend date. Subsequent to the ex-dividend date, the shares may or may not bounce back to their original price point. So if you see your stock behaving with unusual volatility, it may be the victim of the dividend capture strategy. A free website that allows you to access information on ex-dividend dates is:
http://www.dividend.com/ex-dividend-dates.php
Market tone:
The continued volatility in US markets, mixed economic reports and fiscal concerns in Europe has caused a downturn in the stock market and is keeping trillions of dollars on the sidelines. We need to get that money back in circulation to get our economy moving again. Here is a summary of this week’s reports:
- Industrial production increased by 0.9% in July, the largest monthly increase this year. The main factor was increased car production.
- Construction of new homes declined in July by 1.5%
- Existing home sales fell by 3.5% following an increase in May and June
- On a positive note existing home sales are 21% higher than a year earlier
- Consumer and producer prices rose in July by 0.5% and 0.2% respectively. However, core CPI is below the Fed target
- in July rendering inflation not an immediate concern
- Leading economic indicators rose 0.5% in July, the third straight monthly increase
For the week, the S&P 500 declined by 4.7% for a year-to-date decrease of (-) 9.5% including dividends
Summary:
IBD: Market in correction
BCI: Much like trying to predict the success of a sports team that suddenly gets impacted by a series of unexpected injuries, it is getting more and more difficult to predict a pattern in our stock market. With political and global concerns causing market psychology to rock the market in both directions a defensive posture is sensible for those remaining active in these current market conditions. I am selling only in-the-money strikes, using more exchange-traded funds (from our premium report) and purchasing index securities when there is a large market decline. Those new to stock and option investing may find the current market conditions a bit challenging but certainly should continue to paper trade as a learning tool.
My best to all,
Hi Alan,
Is there a way to predict the likelihood the option will be exercised prior to the ex date?
Thanks a lot.
Marion
Premium Members,
The Weekly Report for 8/19/11 has been uploaded the the Premium Member’s website.
Best,
Barry
Marion (#1),
There are two factors to consider that will increase the chances of assignment:
1- The dividend is greater than the time value of the option. Let’s say the quarterly dividend is $0.75, the stock price is $43, the option strike is $40, and the option value is currently $3.25 $0.25 time value). The option holder can buy the stock @ $40, capture a $0.75 dividend and sell the stock @43 (if price remains the same) for a credit of $3.75. The other choice would be to sell the option for a credit of $3.25. Assignment is much more likely in this scenario than had the time value of the option been greater than the dividend.
2- The closer the delta is to “1″ the greater the chances of assignment. As delta approaches 1 the market perception is that there is virtually no chance that the strike will end up out-of-the-money by expiration. DEEP in-the-money strikes have deltas at or near “1″.
Alan
Alan,
How concerned should we be about our shares being sold due to divdends? Should we avoid selling options when dividends are about to be distributed?
Thank you.
Steve
Steve,
I don’t believe that there should be any concern at all about shares being sold due to dividend capture assuming there are no tax issues of concern. It’s important to identify the strategy and goals you are looking to achieve and not let goals of another strategy cloud your results. If we are using covered call writing to generate 2-4% per month in normal market conditions losing out on a dividend is not an issue as long as our goalos are achieved. As a matter of fact, if our shares are sold early enough in the contract cycle, we can use the cash to generate yet another income stream in the SAME month with the SAME cash. The purpose of this article is to explain periodic unusual behavior in a stock price prior to an ex-dividend date.
Alan
What is the best way to tell if a stock on the premium list has an ex-dividend date coming up?
Thanks for your help.
Fran
Allan,
Several of the stocks and ETFs on your watch lists are related to gold which makes sense. Do you think it may be too risky to enter these positions with gold going up so much lately? All opinions appreciated.
Tom
Fran (#6),
First check the % Dividend Yield column of the “running list” which is found in the last 3 pages of the premium report. If there is no dividend, no need to check. If there is, use the link I provided in the article above.
Alan
Anyone know anything about the etf VIXY? Check out the premiums: 11% in 1 month!!! Alan always says that if it seems too good to be true it usually is. What am I missing?
Pam
Thomas (#7),
History shows us that frequently when the market and economic outlook is negative investors turn to gold. It’s almost more of a psychological factor than a tangible one. In these instances, gold has an inverse relationship to the stock market. In the past 6 months GLD one of out top-performing ETFs has been up in value by 35% while the S&P 500 has declined by 15%. I agree with you that things can turn around but this run could also have legs for a few more months. A conservative approach would be to sell in-the-money strikes with stocks and ETFs that are currently most favored by the institutional investors. I constructed a chart to show GLD increasing (red arrows) while the S&P 500 declined (green arrows). See below. Click on the chart to enlarge and use the back arrow to return to this blog.
Alan
Why not do it in a IRA, retirement acct, and pay taxes later
Pam (#9),
The VIXY is based on future expectations of the volatility of the S&P 500, not on a directly investable asset. Futures contracts are more complicated and have different rules than standard ETF contracts. When we see an 11%, 1-month return we know the implied volatility is extremely high, increasing our risk as the underlying can whipsaw significantly in either direction. It reminds me of the Taser example I give in my first book where a high option return enticed me into making a foolish investment. I learned my lesson. Before using an underlying such as VIXY make sure you fully understand the product you are buying and risk you are incurring. Once you do, the decision will be the appropriate one.
Alan
Alan,
Thanks for that perspective. Seems to be holding true today as the market is up and gold is down.
Thomas
J. Dos (#11),
Excellent point. Trading in sheltered accounts is advisable not only for the dividend capture strategy but also for conventional covered call writing and many other option strategies. For those of us who do not have the eligibility to take advantage of sheltered accounts it is important to understand the tax ramifications of short-term capital gains.
Alan
Thomas (#13),
S&P 500 up 3.4%
GLD down 3.6%
Explains why some investors hedge with gold positions.
Alan
Alan,
What criteria do you use for your list of exchange traded funds?
Love the site!
Eddie
Eddie,
We eliminate ETFs that are leveraged and trade less than 250k shares/day. We highlight the ETFs that have outperformed the S&P 500 by the greatest percentage over the past 3 months. We also screen for ETFs with a RS rating > 80%. In week’s when there are not an adequate number of candidates we may drop the RS rating requirement to 70% and note that on the report.
Thanks for the kind words.
Alan
Steve Jobs resigns:
http://www.marketwatch.com/story/apple-ceo-steve-jobs-resigns-2011-08-24-1843500?siteid=bnbh
Pre-market Apple is down only $6. I was looking to get in if there was a big dip but that doesn’t look likely.
Good luck trading.
Amy
Amy,
I think the mild decline was to be expected as Jobs has been suffering from a serious form of cancer for years. This is not a shocking announcement. It is sad.
Fred
Premium members:
This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site.
For your convenience, here is the link to login to the premium site:
http://www.thebluecollarinvestor.com/member/login.php
Not a premium member? Check out this link:
http://www.thebluecollarinvestor.com/membership.shtml
Alan and the BCI team
MCD:
One of the handful of stocks that made the BCI “running list” this past week had a stellar 2nd quarter earnings report on July 22nd. Revenues increased by 16%, operating income rose by 19% as did earnings over the same quarter last year. Analysts are projecting earnings growth of 16% and 10% over the next two years.
In the second quarter MCD spent $748M in share buybacks and $632M in dividends. The current dividend yield is 2.8%, 50 basis points above the yield of a 10-year Treasury note. It trades at a reasonable 16x forward earnings. Our premium watch list shows a beta of 0.47 which is appropriate for volatile market conditions.
Alan
To our members:
I wanted to update you on the upcoming premium stock report and weekly blog article. As you know there is a devastating hurricane moving north on the east coast where the BCI team resides. There is a significant chance of a power outage and we are taking every step possible to maintain the quality of service you deserve:
• The information necessary to produce the premium report is available to us by 9PM EST.
• We have all our spreadsheets ready to go once we have the information
• We will work through the night tonight or as long as the power situation permits
• Mother Nature permitting, we will publish the report and notify you by direct email and blog posting as always
• The weekly blog article will be published later tonight or early tomorrow once again, Mother Nature permitting
• If and when the Premium Report is uploaded to your premium site, I would suggest printing it out as I am unsure if power will be lost to the servers supporting the site
• My team and I will keep you updated as to the progress of these reports and articles unless of course we are shut down by the storm
• Should we lose power, you will hear from us as soon as we are back online
My team and I appreciate the tremendous support you give us and will do everything possible to provide the quality of service you deserve.
Thanks for your understanding in this matter and please STAY SAFE.
Alan and the BCI team
I would suggest you all visit us out here in the southwest USA until the storm out there in the east is over. It is only about 115 degrees here. {ugh) At this point, tho, I think the temp may be easier to handle than storm damage. In any case, well wishes to Alan and all.
Don B.
My brokerage house (OptionsXpress) warns that if you are short a call option prior to X-Dividend date, someone (or institution) who wants to capture the dividend might exercise it the day before X-dividend date. You would be notified ON X-dividend date and WOULD BE PERSONALLY LIABLE TO PAY THEIR DIVIDEND. If the call was a covered call, this means you would have to pass the dividend you got on your stock along to the call exercizer, right? Kinda puts a kink into selling DITM LEAPs to increase the dividend yield on long-hold stocks. Comments?
S.A.,
To circumvent this issue in many instances consider watching the delta of the option and rolling the option prior to the ex-dividend date if the delta is @ .95 or greater. Here is a link to an article I published on this topic:
http://www.thebluecollarinvestor.com/blog/using-covered-calls-to-increase-dividend-yield/
Alan