Safe Dividend Capture Strategy?

Posted by sjscud on September 18, 2010 (12:39PM)

I have been looking for a safe dividend capture strategy and I believe that I have found a good approach, but I would like feedback since I may be overlooking something.

Goal: Collect dividend from high dividend stock and provide some protection of stock price deterioration. In other words, protect your principal.

Strategy: (example)

1. Locate high div paying stock like FRO (10.4% div) which also has some option volume.

2. Buy FRO stock at $28.00 and immediately buy deep in-the-money option far out in time. For example purchase Jan 2012 $17.50 option for $10.50.

3. If FRO stays above $17.50 over the next year (a good chance) you will collect the 10.4% dividend.

4. When FRO stock is called away in Jan 2012, look for another acceptable stock and repeat the process.

It seems to me that this is a good way to provide some protection to your principal and collect a steady dividend stream.

Does anyone see any problems with this strategy?  I believe that I would only pay tax on the dividend since the option transaction and the stock transaction should cancel each other out.

Sjscud

Posted by jdenys on September 18, 2010 (12:54PM)

Hi sjscud, this is just my opinion, but over the last two years I have been chasing high dividend stocks, and finally I have seen the light!! Here is the problems I see, first off your making the large assumption that the dividend will remain the same and not be lowered. Usually these stocks that offer 8%+ dividends always fall in time, as usually most if not all of the dividend is a return on capital. Look at the stocks CPF as well as AOD, AOD for instance was a dividend capturing stock, all was going well until they could not keep there dividend level, and they cut it and then the stock plummeted. Same with CPF however they did not have the same dividend capture strategy. I know it may look very attractive to see the high dividend yields of these stocks, but I have learned that its like playing with fire, and that eventually the stock will fall, and the dividend will get cut. Just my opinion though.

Posted by OldFart on September 18, 2010 (01:59PM)

sjs - there is no "safe dividend"strategy, believe me you are not the first one to try to find it. Everybody knows about the dividend and the option prices reflect it. Look at it the other way - u r trying to get some risk-less aka free money and the MM being the gatekeepers do not like that
One approach I have tried a few times in the past is to buy a call spread, long call deep ITM and short call ATM. Now some times later the day before the ex-date if it still makes sense I will exercise my long calls with the idea to get the dividend. Worst case scenario is the shares drop and it this case the max loss is limited to the price of the call spread which is usually much better than the price of the shares

Posted by spshapiro on September 18, 2010 (10:43PM)

“Buy FRO stock at $28.00 and immediately buy deep in-the-money option far out in time. For example purchase Jan 2012 $17.50 option for $10.50.”

If  you do this you are receiving nothing for the time value of the option which has 16 months to run.  Isn’t tying yourself to the obligation to sell the stock at a price that is 10.5 below its present value worth something?  I for one wouldn’t sell a call one month out without some consideration for the time.

Posted by sjscud on September 19, 2010 (08:29AM)

spshapiro wrote:

If you do this you are receiving nothing for the time value of the option which has 16 months to run.  Isn’t tying yourself to the obligation to sell the stock at a price that is 10.5 below its present value worth something?  I for one wouldn’t sell a call one month out without some consideration for the time.

Sjscud:
Thanks spshapiro, I have also thought about this but remember, I am only selling the deep ITM call as insurance. My goal is to sit back and collect the 10% dividend on the stock without worry.  I don't care about making money on the option and I don't care if the stock goes up or down. As long as the stock stays above my $10.50 strike price I am protected.

This seems to be a simple way to collect income. Better than buying bonds or CDs at the bank.

Posted by spshapiro on September 19, 2010 (11:20AM)

 Sj, There’s a world of difference between a stock and a bond or a CD.  With the latter, unless the company goes bankrupt or the CD is above the federal insured limit, you will receive the principle back at maturity and most likely with the agreed interest rate.  There is no such guarantee with a high dividend stock.  I as well had a fascination with high dividend payers, and still take consideration of the dividend quite seriously.  Dividends are far less certain than interest payments, that is not really an issue of debate.  For that reason I look at the history of payments by the company, asking for how much?, for how long? And how frequently have they raised payments? Have they reduced or eliminated payments in the past?  Also, is the dividend covered by current earning and by what percent?   Without due consideration of these factors, you are playing Russian roulette with your portfolio. It may well work out, but are you really going to trust your financial life to the spin of the cylinder?  Remember before they got cute in the financial industry they used to call high yield “junk”.

Posted by OldFart on September 19, 2010 (12:36PM)

sj - I am not saying all of the market participants are Ph Ds but you can not rely on that. You are selling deep ITM call to protect yourself. In general the owner of these calls will exercise them to get the dividend, especially if the price of the puts at that level is less than the dividend. True, some people forget to exercise, maybe 10 - 20% of your calls will slip and you will get the dividend

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