Post by lorenzo on Nov 3, 2013 12:29:57 GMT -5
"I get that people THINK it's something that traders do, but it seems like a myth. Like I said before, I've never heard of anyone who actually does this. And since I can't imagine there's any edge to be had there, I can't imagine anyone consistently does it."
I've since retired, but when I used to trade, I often participated in dividend spreads. They are low risk and potentially high reward. They are still done, and I'm sure we'll see a huge spike in volume on any deep call line with decent open interest.
There is actually pretty decent expected value in a lot of these trades, thus much different than buying stock before a split. The idea is to get short a lot of calls on lines with large oi- ideally multiples of the oi. This is done mainly by doing 0 delta deep call spreads and exercising the long side of the spread. This leaves you short calls and long stock. You then hope that you don't get assigned on as many calls as possible. Your risk is you don't cover the commission costs of the trade (which becomes substantially reduced per contract with large volume) with the dividend proceeds from unexercised calls. Your profit = div proceeds from unexercised calls - (commission of trade + call extrinsic value).
Also, a good rule of thumb is if the put on the same line as your long call is worth less than the div payment, the call should be exercised. If for margin reasons, you can not exercise the call, then close it out or roll it up to a nonexercise call. This should be done on the day before the stock goes ex.
Lorenzo, here's my original post on the topic from Friday. (see below) The strategy of writing calls that you and I describe isn't what they're taking about. They're talking about going long into a dividend unhedged with the belief that the stock won't fully correct for the dividend the following day.
"Just out curiosity, do you know anyone who actually does this (Buy right before ex-dividend with the intention of dumping right after)? I've honestly never seen or even heard of any trading firms or individuals to ever do this.
The only strategy I've heard of is firms who write a ton of way-in-the-money calls right before ex-dividend (with a 100% hedge) with the hope that a significant number of those calls will go unexercised and they can profit on every call they still have short the day after ex-dividend. There's definitely edge in that strategy, the only question is how many calls go unexercised. But where exactly is the edge in buying a stock right before a dividend when known dividends are always completely priced in?"
Got it- sorry I thought it was in the context of div spreads. My bad.
Don't forget to exercise!