Can you earn dividends using options without holding shares long-term?
Dividends are part of a company’s profits that are awarded to shareholders for having part ownership in the company. Dividend capture is an options trading strategy where the goal is to hold the stock long-term, but to also profit from the dividend payout. We’ll explain all about how to use this strategy to enhance your overall payouts in options trading online.
In this post, we’ll break down how options can help you execute dividend capture strategies—and whether it’s worth the risk.
What Is Dividend Capture?
Dividends are a portion of a company’s profits that are distributed to share holders—it’s a reward that’s paid out in cash for investors who own part of the company’s stock. Dividend capture is a strategy where the investor buys a stock right before its ex-dividend date. They collect the dividend and then sell the stock right after. The goal with dividend capture is to hold the stock short-term but to also profit from the dividend payout.
Key Dates to Understand
- Declaration Date—The date when a company’s board of directors approves and announces a dividend payment to shareholders. You’ll typically see a company’s retained earnings reduced along with the creation of a liability (the dividend payable) on this date. The declaration date also includes key details like the dividend amount, payment date, and the ex-dividend date.
- Ex-Dividend Date—The cutoff point that determines if the stock buyer will be entitled to get their next dividend payment. This also refers to the day that the stock starts trading without the dividend attached. Traders who want to receive a dividend must purchase the stock before the ex-dividend date.
- Record Date—The specific date a company uses to determine which shareholders are eligible to receive a declared dividend. It’s usually set a few days after the ex-dividend date.
- Payment Date—The day a company distributes its declared dividends to eligible shareholders.
Why Some Traders Pursue Dividend Capture
- Income-Focused—Dividend capture is a short-term strategy that focuses on generating income from dividends rather than focusing on long-term capital appreciation.
- Yield Enhancement—Because this move is focused on purchasing the stock right before the ex-dividend date, getting the dividend payout, and then reselling the stock, dividend capture can greatly enhance the profit they receive from the dividend yield without long-term exposure.
- Quick Returns—It’s possible to enjoy quick returns, and your capital isn’t tied up for long periods.
- Good for Diverse Markets—Dividend capture can be widely applied because there are thousands of dividend-paying companies. This lets dividend investors use the strategy in a wide array of international markets.
Why Use Options for Dividend Capture?
Dividend capture has a strong appeal for a lot of investors, and we’d like to draw your attention to some of the best reasons for using this strategy. If you’re looking for a good reason to embrace the dividend capture strategy, check out some of its greatest perks and benefits.
- Income Generation Through Quick Returns: Avoid tying up large capital with long stock positions and simply buy stock right before the ex-dividend date.
- Use Leverage to Your Advantage: Traders can use dividend capture to control 100 shares with one options contract.
- Hedging: Dividend pasture has the potential to reduce downside risk or improve timing.
- Arbitrage Opportunities for Advanced Traders: Experienced investors can use dividend arbitrage to exploit price differences between a stock and its options around the time of the ex-dividend date. This one is more of a selling point to seasoned traders, but it’s also worth noting that there are some tax implications for collecting dividends up to a certain amount and for certain jurisdictions.
Common Dividend Capture Options Strategies
To ensure that dividend capture is producing the profits you’re seeking, you must use an effective options trading strategy to make it a reality. Let’s take a look at covered calls, the one-step covered call put options, and dividend arbitrage to get an idea of which strategies will produce the greatest profit on stocks that offer dividends to their investors.
Covered Call Strategy
To combine the covered call with the power of dividend capture, complete the following steps. This is a good strategy to enhance your overall yield on stocks that offer dividends.
- Choose a stock from a company that offers dividends to its investors. Buy the stock before the ex-dividend date to become eligible for a dividend payout.
- At the same time, sell a near-the-money call expiring just after the ex-dividend date.
- Collect the dividend following the ex-dividend date as well as a premium upfront from selling the call option.
- Keep in mind the risks involved with the covered call after you collect the dividend and the premium following the ex-dividend date. The stock may drop post-dividend or get called away, which means that traders would lose their premium (the price paid to enter the call position).
Buy-Write Strategy (One-Step Covered Call)
Also known as the “one-step covered call,” the buy-write strategy involved buying a stock and selling a call at the same time before the ex-dividend date. When the trader sells the call option on the same security, they’re agreeing to sell the stock at the strike price if the buyer of the call option chooses to exercise it.
Good for High IV
Buying stock and selling a call simultaneously before the ex-div date with the buy-write strategy is a good option when implied volatility is high because larger price swings can lead to greater profits.
Timing Matters
It’s crucial to find the right entry point or the right time to adjust an existing position to minimize the risks as well as maximize the total returns. This comes with understanding the market conditions and trends, more so than timing the market perfectly.
Put Options to Acquire the Stock
Selling cash-secured puts ahead of the ex-div date is a strategy where traders can potentially buy a stock at a lower price and generate an income at the same time through collecting premiums from the sale. By selling a put option, the buyer needs to have enough cash to cover the possible purchase of the underlying stock if the put is exercised by the buyer.
Put options can be exercised by the buyer before the expiration date, and they are often exercised early, right before the ex-dividend date, because traders want to take advantage of dividend capture. There are two possible outcomes for traders who are selling cash-secured puts ahead of the ex-dividend date:
- If assigned, you acquire stock in time for the dividend.
- If not assigned, you keep the premium.
Dividend Arbitrage (Advanced)
Dividend arbitrage is an advanced strategy that’s commonly used by institutions—they buy stock and sell deep ITM calls. It’s a more advanced form of a covered call strategy. It involves owning shares of a stock and selling a call with a strike price that’s much lower than the stock’s current market price.
Possible Outcomes
- If the stock price stays below the strike price, the call option will expire as worthless, and the investor or institution can keep the premium from selling the call option. The investors also retain ownership of the stock.
- The other outcome is that the stock price rises while the call option is in-the-money, and the trader could be required to sell their stock at the strike price. They can hold the stock if they envision the price continuing to rise, or they could sell at the strike and still hold on to the premium.
It’s important to note that dividend arbitrage is an advanced move that only should be used by institutions or highly advanced, experienced traders. It’s meant to minimize risk and extract a dividend. Arbitrage, when it comes to collecting dividends, is a more complicated form of trading, and it’s a lot less viable for retail investors.
Key Considerations and Risks
If you’re interested in using a dividend capture strategy, it’s best to know about the significant risks ahead of time. This can give you a good idea if you’re willing to take on the risks of dividend capture in the pursuit of enhanced profits.
- Early Assignment Risk—This is especially the case with in-the-money calls. Traders run the risk of the buyer of the option contract exercising before the expiration date, obligating the seller to buy the shares at the established strike price.
- Ex-Dividend Price Drop—The price of the stock will usually drop on the ex-dividend date due to the fact that new owners aren’t entitled any more to the next dividend payment. If traders aren’t careful with timing, they could lose some significant money, especially if the price reduction is greater than the dividend amount.
- Taxes on Dividends—Keep in mind that dividends are subject to taxation, but the taxation rate is all dependent on how long you’ve held the shares and your current tax bracket. There are qualified and ordinary dividends. Qualified ones are more favorable due to being taxed at the lower long-term capital gains rate. Ordinary ones are taxed at the ordinary income tax rate.
- Commissions & Spreads—As is the case with other forms of trading, dividend capture strategies are subject to profit erosion from excessive trades that can amass commissions and fees. This is especially the case in smaller trades where the dividends that could be raked in don’t outweigh the commissions or fees.
- Market Volatility—Good timing is paramount in making dividend capture work. Unpredictable market conditions can make timing these trades difficult for traders or investors.
Real Example—Dividend Capture Using a Covered Call
Now let’s walk through a hypothetical trade where you can experience dividend capture through the use of a covered call strategy.
- The first step is to buy 100 shares of a dividend-paying stock. Let’s say that the price per share is $50.
- Next, you must sell a covered call on those 100 shares with a strike price of $53 and an expiration date that’s set right after the ex-dividend date.
- Let’s say this stock pays $2.00 per year in dividends. With the current price being $50.00, the dividend yield would be ($2.00 / $50.00) * 100 = 4%. Not only would the trader be receiving a premium of $1.03 from the call option, but they would also receive a dividend of $2 per share.
Potential Risk: Missed dividends if the strategy isn’t used before the ex-dividend date, loss of the premium for the covered call, missed gains if the stock price rises above the strike price and early assignment.
Outcomes: The stock price stays below the strike price. The call option would expire as worthless and the trader can keep the premium and the stock. The other major outcome is that the stock price rises above the strike price. The call gets exercised and the trader sells the shares at the strike price. They received the premium and the dividend.
When Does This Strategy Make Sense?
What are the best instances for pursuing dividend capture? This strategy isn’t always the best for certain traders or investors, plus there are specific cases and scenarios where dividend capture is a viable strategy and other instances where it isn’t. We’ve outlined the ideal moments where dividend capture makes perfect sense as a strategy.
Favorable For
- High-dividend, low-volatility stocks
- Short-term income strategies
- Traders comfortable with options mechanics
Not Ideal For
- Illiquid options
- Tax-sensitive investors
- Long-term investors avoid churn
Dividend capture is generally best for traders who have the experience and capital needed to enhance the profits and hold up against the potential risks, should the trade go south. It’s also a more short-term strategy and is less focused on a longer time horizon, making it not so ideal for more passive traders or investors.
Tools to Use
Check out the best tools for successfully working dividend capture into your current trading strategy. These resources make it much easier to find the stocks that pay dividends in the first place, allow you to figure out the profit and loss potential on each trade, keep you in the loop on when to execute your move, and impose the right strategies to secure the profit.
- Option Screeners—To find dividend stocks, traders can use these tools to find specific options contracts by filtering them based on various criteria. Option screeners are almost like a search engine for finding the right stocks, even those that pay dividends.
- Earnings and Dividend Calendars—These tools can be used by traders to figure out how much they can earn on each trade in terms of premiums and how much they can earn on dividend-paying stocks in terms of dividend payouts. Traders can decide if certain trades are worth their time and money.
- Options Strategy Calculators—You can start visualizing and evaluating the potential losses or profits from various trading strategies. Find out which strategies secure you the most profit and fit in the best with your current trading plan or risk tolerance.
- Alerts—Traders can use alerts to be notified when the ex-dividend dates are coming up so they can execute their strategy in time. They can also be notified of assignment risks, showing if you’re short or if you have enough capital to cover your obligation.
Dividend Income Meets Options Strategy—Is It Worth It?
Now, for our final thoughts on dividend capture and what we feel is the bottom line on capturing dividends through the use of options trading: Can you really win with options-based dividend capture? The answer is yes, but there are certain traders it’s best for and certain market conditions where it’s more appropriate.
Key Takeaways
- Dividend capture is possible using options—but requires precision.
- Covered calls and put selling are the most accessible strategies.
- Be cautious of assignment and tax implications.
- Ideal for short-term traders seeking yield-enhancing tactics.
- Always run the math and consider your risk tolerance.
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