Deep ITM Call Writing for Dividend Capture

This was spawned from another thread on the stock forums.

***This objective is purely for the sake of dividend capture***

((This is not a debate over whether writing naked puts is superior than covered call writing. We already know that it is, especially when utilizing a ton of leverage beyond your buying power ))


Hypothetical scenario/proposal:

If you have a high quality dividend paying stock trading below $20 range. And you wrote one year out $2.50 strike calls against it. And did NOT leg in, rather purchased a spread for a debit of say $2.60. Would those shares just get immediately called back from you. What are the chances of you holding on to them for the duration??

When you are so deep in the money anyways at that point, is that dime extra gonna matter anyways VS. say you were able to leg in and get the spread for a debit of $2.45 or $2.50. Would your chances be any better of keeping the stock and capturing the dividends??

The real incredible compounding fact on paper at least about this strategy is to see how it works.

Lets say the dividend based on the stock price is 4%. Thats assuming you pay $18 per share. But when buying it for a $2.50 or $2.60 debit, you're saving $15.40 per share, because thats the call premium you are pocketing. So that 4% dividend now turns into a 27% annual return. But I am suspecting that the shares are immediately called from you because of this fact.

 

T is yielding 6%+ at $25/share. The 15C for 1/2011 is trading $0.36 extrinsic, or 1.4% YTM if uncalled. You gain nothing on the upside and risk assignment when the 15P goes penny. Why not structure a higher strike and roll expirations inside the ex-div dates?

 

Thanks for the heads up on T. You bring up a valid point and question.

Not worried about missing potential upside on PPS, because this strategy is for a bond investor. Initially I looked into this premise, because allot of the sexier super high quality investment grade corp bonds with higher coupons at 6% or 7% are selling way way over par right now.

So other than paying way over par for a bond with the risk of the notes being called at par for a potential 20% or 25% capital loss on principle, this super deep ITM call scenario is the closest strategy I could find to emulate it.

 

That is a good idea. And you would effectively have to go with higher strikes because of the shorter time period expiration on the calls. I will look into this as well.

But what do you think about being a year out on something thats $18 now & short $2.50 calls. How long you think you could hold onto them for??

I was thinking if you timed it and entered the spread right before the date of record date, you would still get the dividend which would more than cover the potential slippage loss of the shares being called from you for .10 overpay @ $2.60 + commissions.

 

Yeah, it can work as a yield-enhancer. T will pay roughly 0.37 for holders to the July ex-div date. If you approach that level for the call prem you're doing well, IMO, and can double that div-yield in an average year. I've done it on OTM strikes in the synthetic straddle. Own T and write 2*shares in the July 27C at $0.21 here. $0.40 net of commission at 8% OTM. Risky on the upside, but T is not a takeover risk.

 

Buy and sell the option at the same time at the same price (called crossing) on the day before ex.

A rule allows you to exercise an option even if you sold it later as long as it's all the same day. You hope you don't get exercised on your short, then you gain the divi in entirety.

You decide which calls to do based on the OI. Look for OI as high as possible. If it's zero, then you're trading against yourself and flushing money to trading costs.

This is one of the most popular strategies of the guys on the floor here. One huge trader in particular on a different floor (don't know his name) does this for huge size - like trades 250,000 crosses for a 0.15 divi or whatever. He crowds out the rest of the market and makes a good living off of it.

Every once in a while you can find one that goes unnoticed.

One risk... You're short the baby puts (by put call parity), so the divi must be >> the put price to buy back the next day and pray there's no stock plunge before then.

 

Yeah, I would rather sell the put in that situation, but you're not going to receive any premium under the 10 strike, at least not in anything blue-chip.

 

Thanks for taking time to share that. Very interesting.

 

I suppose depending on your view of BP you could sell the Jan11 25 Call for $20.20. BP pays a div of $0.84 a quarter, so if you get called out early there's a very little profit for you, however collecting just 1 div payment of the 3 remaining this year makes this a winner.

Of course if you were convinced you wouldn't get called out till closer to expiration you sell the same 25 strike Call for Jan12 for the exact same price 20.20... which would theoretically allow you to receive a few more div payments.

JMHO of course!
Happy Trading

 

This is the dividend lottery game, I have outlined it on this forum many times over the years. There is a catch… its really better if there are two strikes with high OI because you can’t buy and sell the same option to yourself. In this case you can buy and sell the spread of the two strikes as many times as you like for parity or FV. Then of course you hand in an exercise card for each of your buys and hope and pray you don’t get assigned on all of your short side of the spread. The only way you make money is if you end up with a short position in a strike with a lot of OI and not all of the longs in that strike are astute enough to exercise their calls for the stock and dividend. In this day and age it’s not very profitable, but there was a time when you could do it for a decent profit.

That jaggoff MM can tell you stories about doing it 250k times but its meaningless if there is not massive OI in the strikes he trades back and forth.