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Options trading: The Dividend Collar, An Example

Posted July 5, 2012

Topics: Finance & Investing

I have been blogging extensively about the risk-free, double-digit returns possible with the dividend collar. Most traders are curious and positive about this, but a few have claimed it will not work. Here is an example of a recent trade on which the dividend collar would have worked profitably - double-digit annualized returns and elimination of market risk.

[Note: A correction was made to the example, below, on July 16, 2012.]

The dividend collar is designed to move into long stock, long put and short call before ex-dividend date, and then exercise out between ex-dividend and option expiration. Either your short call is exercised, or you exercise your long put. The strike has to be higher than your basis in stock, and the net of the two options has to be zero or a small credit.

Here is one example of the strategy:

Kite Realty (KRG)

Closing price on June 29                     $4.99

Dividend yield:                                   4.81%

Dividend amount per share:                0.06

Ex-dividend date:                               July 3

Options expiring July 20                     July 5 calls @ 0.30

            (21 days)                                 July 5 puts @ 0.30

Actions:

                        Buy 2,800 shares @ 4.99=                  $13,972

                        Buy 28 puts @ 0.30 =                         -$     840                                 

                        Sell 28 calls @ 0.30 =                         $     840

                                    Net options credit                   $         0

Outcomes:

                        Calls or puts are exercised,

                        Net capital gain, 0.01 per share =       $      28

                        Estimated transaction costs:

                         Stock (buy and sell)                           -$      18

                        Options: 28 round trips each, 112

                                    total; (8.95 x 4) + (0.75 x 112)-     120

                                    Net total losses                        -$    110

                        Net options credit, less total losses     -$    110

                        Dividend, 0.06 per share =                 $    168          

                                   

                        Net return based on strikes, dividend only:

                                                $0.06  ÷ $5 = 1.2%

                                    Annualized:

                                                ( 1.2%  ÷ 21 ) x 365 =  20.9%

                        Annualized with stock/option losses deducted: [i]

                                    Net loss: $168 - $110= $68

                                    $68 ÷ $14,000 = 0.5%

                                    ( 0.5%  ÷ 21 ) x 365 =  8.7%



Annualization is based on the option strikes of 5, with 28 contracts of both calls and puts, or $14,000 total. This produces double-digit returns.

This example is from my new book, "Options for Risk-Free Portfolios" to be released late in 2012 or early in 2013.