What are the characteristics of this option strategy?
Dividend capture with options means buying the stock before the ex-dividend date and selling a call against those shares, so that the dividend comes from the stock and the call premium is separate income. To capture a dividend you must own the shares on the ex-dividend date, because option holders are never paid dividends. The approach is most effective when the stock has a large dividend payout and when the options are relatively expensive.
Is this a bullish, bearish or neutral strategy?
This is a neutral to mildly bullish strategy. The short call caps the upside, and the trader is not taking a directional view by selling it. That does not mean the position has no market exposure: you own the shares, so you carry the full downside of the stock. The dividend and the premium together are small next to what the shares themselves can lose.
Is this a beginner or an advanced option strategy?
This strategy is considered intermediate level because it requires knowledge of option pricing and the ex-dividend date of the stock. It is also important to understand the impact of volatility and time decay when trading options.
In what situation will I use this strategy?
This strategy is best used when there is a high dividend yield, the options are expensive and you expect minimal movement in the underlying security.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The reward is capped and the risk is not. The risk is unlimited unless the call is fully covered by 100 shares of the underlying per contract. Selling a call without owning the stock leaves the trader exposed to an uncapped loss if the stock rallies. Even when the call is fully covered, the downside is real and large: the shares can fall much further than the dividend and the premium together, and the worst case is the stock going to zero while your gain was fixed at the strike. The reward is limited because the premium received will be lower than what would be earned by selling the option outright, and the dividend you collect is roughly the amount the share price drops on the ex-date.
How is this strategy affected by the greeks?
This strategy is significantly impacted by the greeks. The short call on its own is short delta, short gamma and short vega and long theta, but you hold it against 100 shares, so the package is net long delta below the strike and flat above it: the call's losses on a rally are paid for by the shares, which is what caps your profit rather than what creates a loss. Time decay works for you, since theta on the short call accrues to you each day the shares stay put. The exposure that is not hedged is the downside in the stock, and a short in-the-money call also carries early assignment risk just before the ex-dividend date.
In what volatility regime (i.e VIX level) would this strategy be optimal?
This strategy is best used when implied volatility is high, since richer option prices mean a larger premium for the seller.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
The mechanics of adjusting are easy, but the adjustments do little for the risk that actually matters. If the underlying rallies, the short call gains value and your upside is already capped, so the choices are to buy the call back at a loss and keep the shares, or to let the shares be called away at the strike. If the underlying falls, the short call loses value and can be bought back cheaply, but the shares are losing more than the call is making. Rolling the call down and out brings in a little more premium and lowers the effective cost basis by that amount only. It does not protect against a large decline; only selling the shares or buying a put does that.
Where does this strategy typically fall in the range of commissions and fees?
This strategy typically falls in the mid-range of commissions and fees. Since you are selling the option, you are exposed to commissions when entering and exiting the trade.
Is this a good option income strategy?
This can be a good option income strategy if the underlying security has a high dividend yield and the options are relatively expensive. However, it is important to understand the risk profile of the strategy, as it is limited in its reward potential.
How do I know when to exit this strategy?
You should exit the strategy when it no longer meets your criteria. This could be due to a change in the underlying security’s dividend yield or an increase in implied volatility.
How will market makers respond to this trade being opened?
Market makers price the expected dividend into the call well before the ex-date, so there is no surprise for them to react to. The practical consequence for you is early assignment. Any holder of a deep in-the-money call, market maker or not, will often exercise on the day before the ex-dividend date in order to own the shares and take the dividend. If that happens your shares are called away and the dividend you were trying to capture goes to the option holder instead.
What is an example (with calculations) of this strategy?
For example, assume you are trading MSFT, which is trading at $250 and pays a $1.50 dividend. Before the ex-dividend date you buy 100 shares at $250 and sell one 250-strike call expiring in one month for $5.50, collecting $550 in premium less commissions and fees. On the ex-dividend date the shares trade down by roughly the dividend amount and you are credited $150 in dividends.
The best case is that MSFT is at or above $250 at expiration. The call is assigned, you deliver the shares at the $250 strike, and you keep the $550 premium plus the $150 dividend for a maximum profit of $700. That $700 is the ceiling no matter how far MSFT rallies. If MSFT finishes below $250 the call expires worthless, you keep the shares and the premium, and your downside breakeven is $250 less the $5.50 premium less the $1.50 dividend, which is $243.00. Below $243 the position loses money dollar for dollar with the stock: at $220 the shares are down $3,000 against the $700 collected, a net loss of $2,300. The premium and the dividend cushion the first $7 of decline and nothing beyond it.
MarketXLS and How it Can Help
MarketXLS is an Excel-based data and trading platform that provides investors and traders with access to accurate and up-to-date stock and option data. With advanced options analysis tools, such as Dividend Capture Strategy, traders can quickly and easily evaluate potential trades and determine their probability of success. MarketXLS can help traders manage risk by allowing them to quickly adjust their trades if the markets shift. Additionally, MarketXLS’ advanced charting capabilities can provide traders with valuable insights into the performance of their trades and help them identify the best entry and exit points for each trade.
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