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Options Trading - The Dividend Timing Strategy

By  Jun 23, 2011

Topics: Finance & Investing

By timing entry and exit of stock positions with ex-dividend date, you gain exceptionally high annualized returns and can churn capital in and out of positions to great advantage. Using three stocks with different ex-dates, you can earn 300% of the average annual dividend yield by moving in and out of positions--while eliminating all market risk.

The plan involves a careful coordination of stock positions and options:

1. You purchase of 100 shares of stock immediately before the ex-date. This is the date that shareholders of record earn dividends, even though dividends are not paid until several weeks later.

2. At the same time or right before the ex-date you sell a covered call as few points as possible in the money. You also buy a long put. Both option strikes should be in close proximity to current price of the stock, ideally a point or two above. This position--short call and long put with ownership of 100 shares of stock--is either a collar or a synthetic short stock position. If the strikes are both slightly out of the money, it is a collar; if the strikes are identical, it is a synthetic short stock position.

Exercise: Assuming there is some movement in the stock in either direction, one of two things will occur. If the stock moves above the strike of your short call, shares are called away. If the price moves below the strike of your long put, you can exercise it and sell at the fixed strike.

Exercise is desirable because this strategy is designed to earn 300% of dividend yield. You want to get in and out of the stock as quickly as possible, with the sole purpose to earn dividends with no market risk. The market risk is eliminated by the options.

You repeat this every month. So you need three stocks, each with ex-date in different months. One will be in the series of Jan-Apr-Jul- Oct, the second in Feb-May-Aug-Nov, and the third in the series Mar-Jun-Sep-Dec.

It does not matter how volatile the stock is; in fact, the more volatile, the better your chances of exercise. The primary criterion for picking stocks is high dividend yield. There are plenty of companies yielding between 4 and 6 percent, and these are the best candidates. For example, if all three of your stocks have stated dividend yield of 4%, this dividend/option strategy yields 12% per year--because instead of earning 1% per quarter on each stock held throughout the year, you earn 1% every month by moving in and out to be stockholder of record before ex-date each month.

Michael C. Thomsett is an instructor with the New York Institute of Finance. He teaches five  courses: “Swing Trading with Options,” “The Amazing World of Options,” “Synthetic Options Strategies”, “Options timing and dividend income strategies,” and “Using candlestick reversal and continuation patterns to improve timing.”  He is also an investing and options author and has also written for FT Press’ Agile Investor series, which can be viewed on FTPress.com. Thomsett’s latest FT Press book is Trading with Candlesticks. He also contributes to the CBOE blog and to the Seeking Alpha blog.