Startegy to make some money on dividend paying stocks

[usctrojanman29_IHB]

I was researching various larger cap stocks that have dividend yields north of 5%+. The strategy is to buy a stock a day or two before the ex-dividend date (this is after the company declares what their quarterly dividend is) while at the same time selling deep in-the-money covered calls to protect yourself against any possible huge drops in the few days that you'll hold the stock. I have to credit using the selling in-the-money covered calls to BV thread. So on 12/24/08 I bought 1,000 shares of USB (US Bank) while selling 10 $17.50 Jan covered calls. The dividend for USB for this quarter is $.425/share and will be paid in mid-late Jan. 2009. Today I sold off the shares and bought back the covered calls which resulted in a wash. So net of the transaction costs for buying and selling the shares and calls, I'll net a little less than $400. Other larger cap stocks with nice dividend yields are T, GE, VZ, BAC, DT, DOW, RY, and DD. The higher the dividend yield and more shares you buy, the higher dividend profit you can expect to make.

 

[jbenko_IHB]

Sigh...i wrote a whole page and then it errored when I posted.



I'm going to write a very short version as I don't feel like typing it all up again.





You have to buy stock before ex-div, and sell after-ex div. Now lets take a quick example:



You have the following before ex-div



buy 10.00 stock

sell 1.00 call

will receive 1.00 div.



Now what happens ON ex-div day is that the stock price will adjust almost exactly the same amount as the dividend (I say almost because there is a slight difference due to tax calculations). So if you were to receive 1.00 for stock you will lose -1.00 on stock giving you a wash.



Your argument though is that if you sell calls for the stock it should drop in value to cover the loss in stock giving your dividend a free play. This wouldn't work because you have to remember that as the option writer you are responsible for paying the dividend. So in theory yes the option contract should devalue but at the same time it will increase in value as well because of the dividend it is owed. Giving itself a wash...In theory.

Second issue to this is DELTA. If the ex-div date was trading on the same day as contract expiration then the delta would be very close to .99999. Meaning if the stock moves 1.00 the option will move .99999. Anything before that, will net you a loss. Because a 1.00 drop in stock price won't result you an even 1.00 drop in option contract. If delta is .50, you will recoup only .50.

Most of the time in these situations you will actually lose a bit of money if there are pricing discrepencies, but mainly from transaction costs.



Let me know if I'm completely mis-understanding you, but there is no free lunch. Most common way to get a pure hedge is finding undervalued option contract and selling/buying them and doing opposite to the stock price almost at the same time locking in the gain. But this is always picked up by wall-street floor traders well before you even had a chance to blink. I hope this helps, and let me know again if I'm not following your strat correctly.

 

[awgee_IHB]

All, and I mean <strong>ALL</strong>, arbitrage opportunities are taken by professionals. You play with the big boys and you will get the horns.