Papale on Dividends and Calls

We are in an era of streaks right now.  The Dow up 10 straight days.  The Miami Heat – 20 wins in a row.  The Chicago Blackhawks — 24 game point streak. My son needing to be reminded to put on deodorant because 14 year old boys have a tendency to pretty much just stink.  But eventually streaks come to an end.   I don’t like to predict markets but I’ll go out on limb here – the Dow will have another down day – I guarantee it.  The Heat will lose again.  The Blackhawk streak ended last week in Colorado.  And this morning my son put on deodorant on his own.  Some streaks are just meant to end.

One of the big things these days being talked about for investors is yield.  Everyone wants yield.  And one way to find it is by buying dividend stocks.  We as option traders know that we can add even more yield to a  portfolio of dividend stocks by selling calls.  However, if we use this strategy, it is important to be aware that the day before the company goes ex-dividend there is a likelihood that in the money calls will be assigned. This is done so the call holder can collect the dividend, which he cannot do simply by being long the call.

Let’s look at an example.  Say XYZ is going ex-dividend tomorrow and will pay $25.  That mean all shareholder of record on tomorrow’s date will receive the dividend.  If Bill owns a call that is in the money he will likely exercise.  He knows that he must own the stock tomorrow to collect the dividend.  He also knows that ignoring other factors, the stock will open $.25 lower in the morning, reflecting the payment of the dividend.  As a call holder if he did nothing, he would lose value of the call based on the drop in stock price.  An alternative for Bill would be to simply sell the call the day before ex-dividend date.  He would therefore capture the dividend value embedded the price of the call before it goes down the next day.  Either action is ok.   The only action that is not recommended is doing nothing.  This would assure the call holder will lose the value of the dividend by a lower call price.  If you are seller of calls on dividend paying stocks, watch the ex-dividend date and act accordingly.

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