Dividend capture with covered calls

Discussion in 'Options' started by madbrain, Nov 16, 2011.

  1. madbrain


    I was reading the strategy described at http://www.theoptionsguide.com/dividend-capture-using-covered-calls.aspx .

    It goes like this :

    1) Buy stock
    2) Sell an in-the-money covered call
    3) collect dividend
    4) buy the call back and sell the stock

    The obvious catches I see are :
    - you can be assigned before you get to collect the dividend
    - the stock could drop below the strike of the covered call
    - commissions involved

    But it seems to me that this could be worked around.
    1) I could write a call way in the money, with a delta of 1, almost completely eliminating downside risk
    2) I could write it as a very long dated call. The positive theta would act as a deterrent for the call buyer to exercise his option early. It would at the very least cover commissions, if it is indeed exercised early.

    Concrete example :
    1) Buy SPY at $126.08
    2) Sell Dec 2013 $70 call (delta 1). Bid is $56.83 .
    3) Total cost = $69.25 .
    4) If assigned, collect $70. Profit = $0.75 which is 1% .
    5) If not assigned, quarterly dividend would be around $0.63 .
    Buy the call and sell stock at the purchase price. The call will move by the same amount as the stock. There is no profit or loss here, just commissions.
    The $0.63 dividend is the net profit. About 0.9%.

    Seems either way, you can only win. What am I missing ? I am guessing the market for the DITM calls is not huge. But with the LEAPS, it seems to exist, still. One could do this the day before dividend is due.
    And repeat with any dividend stock that has LEAPS.
  2. IMO, options is a very efficient market. When there are arbitrage opportunities (with dividend capture or whatever) it usually means that there is uncertainty about future dividend payments. I've know guys that hedged everything else but the dividend risk and where therefore betting on the future dividend yield.
  3. madbrain



    Thanks, that makes sense. But just how much will it decrease ?
    In my example, for a 2 year LEAPS DITM option, there would still be 7 more more dividends to go before expiration. And the $70 also has $56.08 of intrinsic value.
    Bid/ask spread is indeed fairly large. Bid is $56.83, ask is $57.38 .
    Even at the bid, there is a time premium of $0.75 and intrinsic value of $56.08 . I would the call will stay in the money. So the question is how much the of the $0.75 time premium will be lost after one of the 8 dividends passes. That time premium would have to drop below $0.12 after the one $0.63 dividend for the trade to become unprofitable.

    Edit: strike that, since I would be buying the call back, it's actually good for me if the time premium decreases and the call gets cheaper ;) The call would have to become more expensive after the one dividend by more than $0.63 above the delta to make the trade unprofitable. Maybe it's time for me to go to sleep.

    Even selling at $56.83, and buying back at $57.38, the spread is $0.55 I think the SPY dividend is still more than that.
  4. MTE


    Dividends are priced into options so there is no "arb" to exploit.

    Also, if you are assigned on your short call then you would be assigned on the day before the stock goes ex-dividend, which means you would be responsible for paying the dividend (assuming you don't own the stock and thus you would be short stock on ex-dividend), or your long stock would be called away, which means you don't get the dividend.

    In other words, whether you are assigned or not, you do not gain anything.

    EDIT: Let me phrase this differently, if you think that market makers and big institutional traders have higher transaction cost than you, are stupid and like to leave money lying on the floor then go ahead and do this strategy. If, on the other hand, you think that market markers and big traders have lower transaction costs and are smart then you would realize that any potential gain would be eaten up by your transaction costs.
  5. .. Unless I have misread something ..

    Example looks "good" as written, but I would be surprised to actually see these prices in the market. This is the sort of thing that market makers exploit very quickly, until it doesn't exist anymore.

    Nice work in figuring it out though ;o)

    [Where's atticus ?]

    Oh, wait, Dec 2013 .. ok .. something about not factoring in the cost of carry.
  6. What was the put side trading at? If its greater then 0 then your have the answer. If there is a credit conversion(div factored in) the arbs jump on that very fast.
  7. spindr0


    Check the prices in real time. The bids of those ultra deep ITM calls trade below parity, reflecting the future dividend(s). Their spreads are wider so the slippage will also chew up some that "free" dividend money that you perceive.
  8. tigerwu


    You need to re-read Sheldon Natenberg. All these simple arbitrages disappeared in the 90's or maybe the 80's....
  9. madbrain


    I would never be short the stock. No margin for me.
    The idea was to be long the stock and write the covered call at the same time. I would use a combined buy-write order. I would do this maybe the day before ex-dividend, or a couple days before.

    If I'm assigned the day before ex-dividend, I don't get the dividend, but I get to keep the time premium from the covered call. That actually seems to be the most profitable case, since with a call 2 years out, the time premium is in fact greater than one quarterly dividend.

    If I am not assigned, then I do pocket the one quarterly dividend. Apparently, the catch is the spreads in this case, on both stock and the option. I wouldn't be able to buyback the call and sell the stock without taking a loss, even though the option has delta 1 .

    No, I certainly don't think that, which is why I asked what the catch was ;)

    I could try this with a new account during a promo period without commissions. Then the issue is strictly the spreads when buying back the call/selling the stock.
    #10     Nov 16, 2011