Can I Buy Stocks Just For The Dividend? - Option Posts

Can I Buy Stocks Just For The Dividend?

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DIVIDEND CAPTURE Strategy

One seemingly profitable trading strategy is dividend capture.

Here, an investor focuses on buying stocks just before the stock’s ex-dividend date in order to collect the dividend payment and quickly selling the stock afterwards.

This seems like an almost risk-free strategy because you are only holding the shares of stock for a short period of time, while collecting a guaranteed dividend payment.

However, as you will see, there is no free money in the stock market. That means this strategy of trying to collect the dividend payment is not effective at generating a reliable profit.

Dividend Basics

A dividend is simply a cash payment made out to the shareholders. Some companies elect to pay out dividends to their shareholders as a reward for investing in them. These are typically paid quarterly or annually, depending on the company’s policies.

There are four dates that are important to understanding the dividend capture strategy in stocks.

  • Declaration date
  • Ex-dividend date
  • Date of record
  • Pay date

The declaration date is the date when the company declares a dividend payment. In this declaration, the company board releases information like the amount of the dividend payment and when the dividend will be paid.

Any investor purchasing shares on or after the ex-dividend date will not be eligible for the dividend payment. If you want to collect the dividend payment, you have to own the shares prior to the ex-date.

Next is the date of record. This is when the company records which shareholders are eligible to collect the dividend payment. However, this does not mean that you have to own the shares on this date in order to receive the dividend payment. As long as you held the shares through the ex-dividend date, you will receive the dividend payment.

Last is the pay date. This is the date on which the dividend is deposited into your brokerage account.

Dividend Capture Strategy

The dividend capture strategy revolves around purchasing shares of stock just prior to the ex-dividend date to collect the dividend payment and then quickly selling the shares afterwards. If the stock price does not fall by more than the dividend payment, the strategy is profitable.

Let’s say company XYZ is going to pay a dividend of $1.00 and the ex-date is 2/1/2018. Using this trading strategy, you could buy shares just prior to the market close on 1/31/2018 and sell the shares right at the market open on 2/1/2018. Since you were a shareholder prior to the ex-date, you will be on the list of investors eligible for the dividend payment, giving you a quick profit of $1.00 per share.

What’s missing from this plan is that the stock price drops by the amount of the dividend on the ex-date, eliminating the potential profit opportunity. So, if you had bought shares at $50 prior to the ex-date in hopes of collecting the $1.00 dividend payment, the stock price theoretically would fall to $49 to reflect the dividend payment. This drop in the stock price after the ex-date is why the dividend capture strategy doesn’t work in theory.

In practice, the stock price might not actually fall the full amount of the dividend payment because the stock market does not operate in a perfect environment. Sometimes, but very rarely, the stock price could even increase in value after the ex-date due to overall bullish market sentiment. However, the real potential profit is not commensurate with the amount of risk undertaken in using the dividend capture strategy.

Dividend Capture Pitfalls

On top of the fall in stock price after the ex-date, there are two additional reasons why the dividend capture strategy does not work in practice: taxes and transaction costs.

Dividend payments are considered taxable income, creating an additional tax liability under this strategy due to the dividend income. Because the dividend payments are collected under a short-term trading strategy, the dividend income is taxed at your marginal tax rate.

In order to receive more favorable tax treatment, the dividend payment must be considered qualified. A qualified dividend payment occurs if you hold the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.

Next, you have transaction costs, which consist of the brokerage commissions and fees related to buying and selling the stock. Depending on your brokerage firm, this can amount to a significant proportion of the dividend payment, because you typically have to pay commissions both to enter and to exit the stock position.

Even if the stock’s price does not fall by the full amount of the dividend, the tax liability and transaction costs incurred by buying and selling it almost eliminate any potential profit opportunity. Instead, you are just taking on risk, which is never a good trading strategy.

Dividend Impact on Options Contracts

However,  if the stock price will fall by the amount of the dividend, can’t you just buy put options or sell call options to take advantage of the stock price drop? The quick answer is no. There is no free money in the markets.

In fact, the dividend payment is already factored into the option prices, thus eliminating any easy profit opportunities. The price of put options are increased by the amount of the dividend payment, all else being equal. Likewise, the price of the call options will decrease by the amount of the dividend payment.

In the end, there is no risk-free profit opportunity around dividend payments.

Summary

At first glance, the dividend capture strategy seems like a good idea to capitalize on an opportunity for a quick profit. However, upon further inspection, it becomes clear that the stock market is designed to eliminate any “free money” opportunities like these. On top of that, there are tax consequences and transaction costs that eliminate any riskless profit potential that could come from using the dividend capture strategy.

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