One Trader’s Thoughts on a Dividend Capture Trade

Jason sent an example in reply to this Q & A.


An example. Pfizer is going ex-dividend next month. Paying $0.18 div and
currently trading at $18.50. March 18 call selling for 1.10. Break-even
of stock minus div and premium of 17.22.

If called 4.13% earned, if
uncalled 6.84%.

Sell stop limit on shares at 17.22 and buy back the call
(not sure what this would cost, so don't know how to include for further
loss.

***

Thanks for the example Jason,

I'm asking questions below.  I'm NOT looking for answers.  I just want to be certain you think about this and have a plan.

I believe your prices are not accurate.  Right now (Jan 28, 2PM), the stock is 18.75 and the call is only $1.11  That makes a big difference.  Be that as it may, I'll go ahead and use your numbers as well as the ones that I see right now.

1) If you are adopting this strategy for the purpose 'capturing the dividend,' then it's fairly risky.  The dividend (plus option premium) is small and the potential loss is larger.

2) If you are doing this because you like PFE and want to own its shares, then this plan is viable. You already considered risk when deciding that you want to own the shares.

3) You obviously have an exit point in mind:  A stop-loss on the downside and an assignment (sale at the strike price) on the upside.

What happens when the stock is between those prices?  Do you hold and write another covered call, or do you sell?  There's no dividend for another three months, and you appear to be interested in collecting dividends.  Do you hold despite the fact that the dividend is 'far' away?

4) How do you determine the P/L if uncalled?  What stock price are you using?  I believe you made a mistake.

I find it difficult that you believe you can earn almost 7% if uncalled and only 4% if called.  The stock is higher when you are assigned that exercise notice.

When writing covered calls, being assigned yields the maximum possible profit [Yes, I know if the stock price is a penny or two less than the strike, you save on the assignment fee].

5) To estimate the cost of call repurchase, guess a buy-back date, raise implied volatility (due to price decline) by a small amount, and calculate the option's fair value.

6) With your numbers, if called, you sell @$18, and earn $60 (pay $18.50 sell at $19.10) + dividend.  Less cost of carry (interest you did not earn because cash is tied up in stock).

Using the current  numbers that I see, that's $36 earned + dividend, less cost to carry.  Earnings are almost $54.

The put is $53.  If you sell the Mar18 put instead of buying stock and selling calls, you earn $53. 

That's $1 less.  But you save cost to carry, you save on commissions.  You save on an exercise fee. [If you are going to unload the stock @ 17.22, you can buy the put (to close the trade) and will not incur an assignment fee]  At that point, the put should cost the same as selling stock plus buying the call.

I see no advantage to your buying stock for the dividend. 

I am comparing covered call vs. cash-secured naked put.  I am not telling you to avoid either.  Your investment decision apparently suits your needs, and you cannot bet that.

The two strategies are equivalent and have the same P/L profile.  The dividend is taken into consideration by the option prices.  The evidence for that example comes with using my numbers.  You can double check to see that yours are accurate.  But I caution you to use live bid/ask prices, and never use 'last.'

Don't get your data from Yahoo.

600


2 Responses to One Trader’s Thoughts on a Dividend Capture Trade

  1. TR 01/31/2010 at 10:46 PM #

    Mark
    I have a question for you on your “1 cent per weekday left until expiry” rule for determining what you are willing to pay to close (I do know that you don’t always stick to this rule depending on your comfort zone at the time).
    So far in my IC trading I have always tried to close relatively early and I have not minded paying 0.30 per spread to close. I think I have puposely been “generous” in how much I was willing to play to close because I once (over a year ago) had a bad experience with not closing soon enough and I learned my lesson (at least I think I did… but the time since that last event perhaps is making me forget). My comfort zone right now is to sell 2-3 month out condors for a premium of 1.80 to 2.10 with short strike deltas of of about 10-12. As I reflect on how to improve my trading I am wondering if – because I sell options at a relatively low premium – I should not give up 33% (0.60/1.80) of my premium to close.
    Today I am faced with the situation where I own a 10 lot of a Feb RUT IC 520/530/680/690 with a protective FEB 560/660 strangle. Right now the price to close this position is 0.60 (it has bounced between 0.35 and 0.60 last week) and I “feel” that 0.60 is far too much to pay when both of my short strikes are more than 10% away from the current price. My position does not make me nervous at all especially because I own that insurance strangle. I “feel” that I may be willing to pay 0.25 cents to close the whole IC right now but if I pay more than that I am paying too much. I don’t have a scientific reason for the 0.25 cent number but for a IC with both strikes 10% OTM and only 3 weeks left it seems like paying more is not reasonable.
    I would like to hear any thoughts you have of how to find the right price I should be willing to pay to close a position.
    I also would like to know if you have a rule for how long will you hold a position if you can’t find a reasonable price to close it at (for example – do you close at any price when you are 1 week to expiration).
    Thanks again Mark for a fantastic blog. I have learned so much from you.
    Rgds
    TR

  2. Mark Wolfinger 02/01/2010 at 8:25 AM #

    Thanks TR
    1) Old rule was part common sense, part comfort zone.
    2) With 3 weeks to go, I would not be paying more than 15 cents per leg, so 25 cents per IC is reasonable to pay. But that’s enough. No higher.
    3) But, you are taking in less cash that may make a difference is how you think. It’s still a comfort decision
    4) Owning insurance changes things. Unless you can sell that insurance for enough cash to satisfy you – don’t cover.
    Example if you own one call that you can sell for $2, then yes I pay the 15 cents to clsoe. But if you can only get 50 cents for your insurance, then 15 cents is too high to pay.
    Exception: if uncomfortable (which you are not) then get out of position.
    5) I have no rule. But I almost never leave any toexpire. I’ve paid as little as a penny or two to exit. There’s a price at which I don’t care any more. Too much risk for too little gain. Ten cents is that price for me. It may be only 5 cents for you.
    Yes, I close with <1 week to go.
    It was higher bid in the volatile 2008-9 market.
    6) Glad you like the blog. You've been here for awhile.
    ADDENDUM: about one hour later. Today I bought some March call spreads @ twenty cents. 7 weeks prior to expiration. It's the RUT 690/700 C spread. Is it worthless? Is it a waste of money? Not to me