Arbitrage on collecting dividend

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viewer0
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Arbitrage on collecting dividend

Post by viewer0 » Wed Aug 08, 2018 3:31 pm

I am trying to understand if there could be a arbitrage(almost) to buy a stock near ex-dividend date and selling a well in the money call.
e.g. MSFT ex dividend is 8/15; Today closing price is 109.49 buy the stock, sell 8/17 100 call for $9.50, you make nothing upfront, but get the dividend and call gets exercised on 8/17. The risk is MSFT drops below 100 on 8/17 and I would end up owning the stock below 100.

What am I missing ?
Last edited by viewer0 on Wed Aug 08, 2018 3:50 pm, edited 1 time in total.

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vineviz
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Re: Arbitrage on collecting dividend

Post by vineviz » Wed Aug 08, 2018 3:36 pm

viewer0 wrote:
Wed Aug 08, 2018 3:31 pm
I am trying to understand if there could be a arbitrage(almost) to buy a stock near ex-dividend date and selling a well in the money call.
e.g. MSFT ex dividend is 8/15; Today closing price is 109.49 buy the stock, sell 8/17 100 call for $9.50, you make nothing upfront, bit get the dividend and call gets exercised on 8/17. The risk is MSFT drops below 100 on 8/17.

What am I missing ?
The thing you're most likely missing is that options are already priced to account for the dividend.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Wed Aug 08, 2018 3:46 pm

vineviz wrote:
Wed Aug 08, 2018 3:36 pm

The thing you're most likely missing is that options are already priced to account for the dividend.
Thanks for the response. But did not quite get it; In my example where is the fallacy ?

not4me
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Re: Arbitrage on collecting dividend

Post by not4me » Thu Aug 09, 2018 9:28 am

viewer0 wrote:
Wed Aug 08, 2018 3:31 pm
I am trying to understand if there could be a arbitrage(almost) to buy a stock near ex-dividend date and selling a well in the money call.
e.g. MSFT ex dividend is 8/15; Today closing price is 109.49 buy the stock, sell 8/17 100 call for $9.50, you make nothing upfront, but get the dividend and call gets exercised on 8/17. The risk is MSFT drops below 100 on 8/17 and I would end up owning the stock below 100.

What am I missing ?
If you think you'll get the dividend paid to you, that may be what you are missing as you won't. You didn't indicate what kind of order you issued to by at $109.49 -- if a 'buy at close', then you took a chance on the price. But basically, your scenario would seem to net you a $0.01 per share before you factor in any transaction cost. Or did I miss something?

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Thu Aug 09, 2018 9:51 am

didn't understand how the kind of order matters. Assume I bought the stock during the day at $109.49. If I own the stock before ex-dividend date, I should get the dividend.

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Raybo
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Re: Arbitrage on collecting dividend

Post by Raybo » Thu Aug 09, 2018 10:04 am

I once tried a similar strategy except it was based on secondary offerings. I would buy shares in a company on the the secondary offering. Since company shares are diluted by the secondary offering, there would be an immediate drop in the price on the day of the offering. The idea was to try and catch a bounce in the stock on the day of the offering.

This was many years ago and I don't recall the full details. But, my vague recollection is that it wasn't a big winner and I (and the broker whose idea it was) stopped doing after just a couple times.

What you might be missing is that the cost of the call likely has the value of the dividend priced into it already. Finding free money in the stock market is harder than it seems. You aren't the first one to think of this.
No matter how long the hill, if you keep pedaling you'll eventually get up to the top.

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Thu Aug 09, 2018 10:38 am

I know arbitrage is difficult if not impossible.
What I can think of is someone will buy my call before the day of the ex dividend date and I end up not owning the stock, hence no dividend.
Assuming that the cost of the call has dividend priced into it, I still own the stock (if not exercised) and hence the dividend.
Last edited by viewer0 on Thu Aug 09, 2018 10:40 am, edited 1 time in total.

not4me
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Re: Arbitrage on collecting dividend

Post by not4me » Thu Aug 09, 2018 10:39 am

viewer0 wrote:
Thu Aug 09, 2018 9:51 am
didn't understand how the kind of order matters. Assume I bought the stock during the day at $109.49. If I own the stock before ex-dividend date, I should get the dividend.
Ok, I thought you were talking about "on" the ex-div date instead of before. In that case, I think what you've executed is the "dividend capture strategy" in which you've predetermined how to exit the stock. Despite what some think in the lab environment, one can occasionally find price in the real world where you can take advantage of an inefficiency. So, in your example, you have the 1 time dividend payment plus a penny for your pre-tax, pre-transaction profit. The tax will be at your ordinary rate -- that is, short term cap gain & the dividend won't be qualified since it doesn't meet the holding criteria. Question would be whether that is enough compensation for your effort in finding this & the risk of holding the stock (as you said) & some opportunity cost or carrying cost of your money.

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Thu Aug 09, 2018 10:43 am

Yes, my mistake, it is not "on" the ex-dividend date, it is before, I corrected it.
Taxes will not come into play if I do this in retirement account.

not4me
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Re: Arbitrage on collecting dividend

Post by not4me » Thu Aug 09, 2018 10:47 am

viewer0 wrote:
Thu Aug 09, 2018 10:38 am
I know arbitrage is difficult if not impossible.
What I can think of is someone will buy my call before the day of the ex dividend date and I end up not owning the stock, hence no dividend.
Assuming that the cost of the call has dividend priced into it, I still own the stock (if not exercised) and hence the dividend.
Our posts passed each other. I wasn't explicit in previous post, but part of the difficulty (& hence the risk) is the timing between the 2 transaction. Do you buy the stock then sell the call or vice versa? Once the 1st executes, what if the 2nd is not available again? I'm sure if you do a search on the web for this strategy you may get more risk, considerations, etc. Good luck

jminv
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Re: Arbitrage on collecting dividend

Post by jminv » Thu Aug 09, 2018 10:50 am

viewer0 wrote:
Wed Aug 08, 2018 3:31 pm
I am trying to understand if there could be a arbitrage(almost) to buy a stock near ex-dividend date and selling a well in the money call.
e.g. MSFT ex dividend is 8/15; Today closing price is 109.49 buy the stock, sell 8/17 100 call for $9.50, you make nothing upfront, but get the dividend and call gets exercised on 8/17. The risk is MSFT drops below 100 on 8/17 and I would end up owning the stock below 100.

What am I missing ?
You are missing that dividends are taken into account in option pricing models. Also, it is more than within the realm of possibilty that the underlying could be above your breakeven at expiry. There is a 50% probability that the call you are talking about will be greater than 110 expiration in which case you would lose money on writing the option. The only reason that I would expect a strategy like this to be profitable, on average and in the long run, is that people don't write calls unless they expect to profit. In the short run you could lose a lot of money (and by this I mean gains that you would have had but transferred to another, it's still a loss on the options strategy).

Writing options should be expected to be profitable so the 50% probability of profit in the contract above would not interest me much. As of now, if you were looking for a short term, in the money, liquid contract MSFT 8/24 110 calls would be the ones I would sell. The probability of profit is 63% and the expected annualized return would be 24.74%. There is a 37% chance it would be above 111.3 at expiry (where writing the option would become unprofitable). The problem is that there is the potential, even writing a short term call, to lose a lot of money picking up nickels.

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Thu Aug 09, 2018 11:14 am

not4me wrote:
Thu Aug 09, 2018 10:47 am

Our posts passed each other. I wasn't explicit in previous post, but part of the difficulty (& hence the risk) is the timing between the 2 transaction. Do you buy the stock then sell the call or vice versa? Once the 1st executes, what if the 2nd is not available again? I'm sure if you do a search on the web for this strategy you may get more risk, considerations, etc. Good luck
I do a buy/write strategy, meaning, I will buy the stock and sell the call at the same instant with a net debit ( limit order). In my example, my net debit would be $99.99 for the strike price of $100. The order does not execute unless there is a matching buy / sell call order with that price.

livesoft
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Re: Arbitrage on collecting dividend

Post by livesoft » Thu Aug 09, 2018 11:18 am

A great answer is given by @jminv. But I think you have to learn what this is all about by trying it out for yourself. There's nothing like first-hand experience.

So I say: Go for it!

Then come back and tell us what happened. Thanks!
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viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Thu Aug 09, 2018 12:25 pm

@jminv Thanks for your insight
jminv wrote:
Thu Aug 09, 2018 10:50 am

There is a 50% probability that the call you are talking about will be greater than 110 expiration in which case you would lose money on writing the option.
Are you saying this implying that I lose as the upside potential is curbed ?

alex_686
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Re: Arbitrage on collecting dividend

Post by alex_686 » Thu Aug 09, 2018 12:32 pm

Another thing you may be missing is that options settle T+1 while stocks settle T+2. Ex-date is calculated by the number of settlement days between trade and record date. Without looking at the numbers here I would guess that the arbitrage trade for the option holder is to call the stock on the day before the record date - after the standard published ex-date - and get the dividend.

It is an odd little quirk that I have seen much up many of a transaction.

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Thu Aug 09, 2018 12:39 pm

alex_686 wrote:
Thu Aug 09, 2018 12:32 pm
Another thing you may be missing is that options settle T+1 while stocks settle T+2. Ex-date is calculated by the number of settlement days between trade and record date. Without looking at the numbers here I would guess that the arbitrage trade for the option holder is to call the stock on the day before the record date - after the standard published ex-date - and get the dividend.

It is an odd little quirk that I have seen much up many of a transaction.
This should be it , but I am not fully understanding it. Let's say the ex-dividend date is Friday 8/10 ( in a new example) and I sold the covered call much prior. So, I own the stock. Let's say the record date is 8/13. As long as I own the stock on 8/10 (option holder does not call the stock by 8/9 CoB), then I will get the dividend, correct ?

alex_686
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Re: Arbitrage on collecting dividend

Post by alex_686 » Thu Aug 09, 2018 12:56 pm

viewer0 wrote:
Thu Aug 09, 2018 12:39 pm
This should be it , but I am not fully understanding it. Let's say the ex-dividend date is Friday 8/10 ( in a new example) and I sold the covered call much prior. So, I own the stock. Let's say the record date is 8/13. As long as I own the stock on 8/10 (option holder does not call the stock by 8/9 CoB), then I will get the dividend, correct ?
Not correct. Let us work the other way around with the actual date. Your dates included a weekend which makes things more complicated.

Let us say that record date is Thursday, 8/15. You must own the stock on this day. This is what truly matters.

NASDAQ settles trade T+2, so go back to Tuesday 8/13. This is what determines things 99.999999% of the time. This is what gets published. One would think that one is safe at this point.

CBOT settles T+1. So here the ex-date is Wednesday, 8/14. :twisted: If somebody where to exercise their call on this date you would not own MSFT on Thursday, 8/15. The person who exercised the option would get the dividend. It is a evil little quirk.

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Thu Aug 09, 2018 1:51 pm

@alex686 that is a fantastic explanation. Even I can understand it :)

Now to a more complex scenario with weekends in between.

AAPL record date 8/13, ex-dividend is 8/10; I would think that if I own AAPL by CoB today 8/9, I am good to get the dividend. Per your explanation, if anyone exercises the call on 8/10 or 8/11( Saturday), he gets the dividend. Is this possible ? Exercising on 8/10 , would give them the stock on Monday 8/13 ?

alex_686
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Re: Arbitrage on collecting dividend

Post by alex_686 » Thu Aug 09, 2018 2:04 pm

viewer0 wrote:
Thu Aug 09, 2018 1:51 pm
Now to a more complex scenario with weekends in between.
Settlement dates are based on days the market is open, not on calendar days. So you don't count Saturday, Sunday, or any other day the market is closed - like Good Friday. So don't count those - just skip to the next working day.

Another wrench that can be thrown into your calculations is if a President dies - the market closes for that as well. For example, when Gerald Ford died the market closed unexpected closed for 4 straight days - 2 for the weekend, one for New Year's day, and one for Ford. However banks stayed opened. That caused chaos.

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Thu Aug 09, 2018 2:07 pm

Fair enough. Remove saturday from above, so could exercising on 8/10 , would give them the stock on Monday 8/13 ? (Even though I had the stock on ex dividend date )

alex_686
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Re: Arbitrage on collecting dividend

Post by alex_686 » Thu Aug 09, 2018 2:25 pm

viewer0 wrote:
Thu Aug 09, 2018 2:07 pm
Fair enough. Remove saturday from above, so could exercising on 8/10 , would give them the stock on Monday 8/13 ? (Even though I had the stock on ex dividend date )
Yep.

Remember, everything is driven by record date. Ex-dividend date is a artificial construct based on local factors. It is not a law or regulation or anything else.

For stocks we mostly think about the processes that is driven by the stock exchange trading processes on who owns what one which date. Options settle by a different trading process, so different dates. Different markets have different settlement times so I have seen different prices on the same stock that is trading in the US verse Japan. I have seen people lose dividends because they gifted the stock after record date but before record date - so the actual owner of the stock on record date was the charity.

Normally this does not matter. Like I said, exceptions are rare. However we are talking about arbitrage which thrives on exceptions.

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Thu Aug 09, 2018 3:54 pm

I called 2 brokers : Fidelity and Merrill Lynch and asked the question. They both said the same thing. As long as I own the stock on the day prior to ex-dividend date, I will be the record owner of the stock. Even if my call gets exercised on the ex-dividend date, the buyer will not get the stock on record date.

Has anyone has practical experience of happening otherwise ?

alex_686
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Re: Arbitrage on collecting dividend

Post by alex_686 » Thu Aug 09, 2018 4:15 pm

viewer0 wrote:
Thu Aug 09, 2018 3:54 pm
Has anyone has practical experience of happening otherwise ?
Yeah, I do. Not to blow my own horn, but I have worked broker support (answering fiddly detailed technical questions that brokers did not know), Custody & Transfer, and the options desk. So I spent a fair amount of time cleaning up issues like this. I will admit this was a bit over 10 to 15 years ago.

In fairness, we are talking about a edge case here. We are talking about "In The Money" options where record date and expiration date are close. Most brokers would never run into this issue. I remember my Series 7 class instructor telling us to skip over this part because it was so arcane. However there are legit arbitrage strategies around this.

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Thu Aug 09, 2018 6:01 pm

@alex_686 Thanks for sharing your wisdom.

On to the original example of MSFT, I see this

Ex-div date Declaration record date payment date
8/15/2018 Cash 0.42 6/13/2018 8/16/2018 9/13/2018

Why is record date just 1 day after ex-div date ?

Tanelorn
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Re: Arbitrage on collecting dividend

Post by Tanelorn » Fri Aug 10, 2018 3:53 am

viewer0 wrote:
Wed Aug 08, 2018 3:31 pm
What am I missing ?
Your calls will be exercised early and you won't get the $0.42 dividend.

https://ibkr.info/node/2081

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Fri Aug 10, 2018 7:10 am

@tanelorn, Yes, that is exactly what happened. I found out today morning that all my AAPL stocks are gone. What I could have done is roll the call to next week and at least get a little bit more money.

I was trying to execute this technique
https://sixfigureinvesting.com/2010/04/ ... ust-right/

Very good learning for me nevertheless.

alex_686
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Re: Arbitrage on collecting dividend

Post by alex_686 » Fri Aug 10, 2018 11:30 am

viewer0 wrote:
Thu Aug 09, 2018 6:01 pm
Why is record date just 1 day after ex-div date ?
Not sure why. My mind is pretty much wired for T+3 because, like I alluded to before, I was stuck researching many odd-ball edge cases. I have not had to do this since we have moved to T+2.
viewer0 wrote:
Fri Aug 10, 2018 7:10 am
I was trying to execute this technique
https://sixfigureinvesting.com/2010/04/ ... ust-right/
I will question this. Why? I don't see any value trying to capture the dividend via options. We could go into the advantages of either dividend investing or covered call writing - but that is not my issue.

I just can't see any money to be made here. You need to know how this stuff works if you are doing both, but there is no free arbitrage money to made here. Every trader has a Bloomberg terminal which will spit out canned reports on how to execute these trades and how little profit you will generate. The big boys use custom algorithms to grind out pennies here.

livesoft
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Re: Arbitrage on collecting dividend

Post by livesoft » Fri Aug 10, 2018 11:35 am

viewer0 wrote:
Fri Aug 10, 2018 7:10 am
Very good learning for me nevertheless.
Indeed, yes. Actual personal experience is a great way to learn.
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viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Fri Aug 10, 2018 3:37 pm

alex_686 wrote:
Fri Aug 10, 2018 11:30 am

I just can't see any money to be made here. You need to know how this stuff works if you are doing both, but there is no free arbitrage money to made here. Every trader has a Bloomberg terminal which will spit out canned reports on how to execute these trades and how little profit you will generate. The big boys use custom algorithms to grind out pennies here.
I would reluctantly agree :)

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Fri Aug 10, 2018 3:38 pm

In this AAPL experiment I did not lose anything, but just collected a time value premium.

viewer0
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Re: Arbitrage on collecting dividend

Post by viewer0 » Thu Nov 08, 2018 8:36 am

Revisiting this ......
Yesterday I bought 2000 AAPL and sold 20 in the money ($200) calls expiring 11/10 ; The buy/write trade was executed at a net debit of $199.55. I collected a premium of ($0.45x2000) $900. AAPL is ex-dividend today 11/8. 19 calls got exercised yesterday and 1 did not. Can I expect to get dividend of $0.73 for 100 stocks ?

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