How to Capture Dividends with Call Options

Have you ever noticed a stock getting swarmed with heavy call selling activity just ahead of its ex-dividend date? If so, it's possible that you're witnessing the execution of a dividend capture strategy. This options tactic is an arbitrage play, as it's meant to capitalize on minor pricing blips that occur as the result of stocks going ex-dividend.

To play the dividend capture, you'll buy shares of a stock just ahead of the ex-div date, and simultaneously write covered calls against those shares. The call options should be in the money by a healthy amount to ensure they move in close concert with the underlying shares.

For example, let's say XYZ is trading at $15, and it's about to go ex-dividend for $1.00 per share. To take advantage, you could buy 100 shares of XYZ and write a 10-strike call. Assuming this option is worth $5.25, you'll rake in $525 for the sale of the option, while shelling out $1,500 for the purchase of the stock. The net outlay to enter the position is $975.

The next day, when the stock goes ex-dividend, you'll collect $100 in dividend payments. The stock price will have dropped by $1 per share as result of the payout, which means you can sell your stake at $14 per share -- or $1,400 total. The sold call can then be bought to close for $4.25, or $425 (again, accounting for the 1-point drop in the share price). Netting it all out, you've collected $1,500 and paid $425 for a total of $1,075.

After subtracting your cost of $975 to enter the position, your total gain is $100 -- the exact amount of the dividend payout. That's why this strategy is called the "dividend capture."

Bear in mind that the $100 profit doesn't account for brokerage fees or transaction costs, and there are at least four transactions involved. That's why the dividend capture is best-suited for institutional investors and other deep-pocketed players who can afford to trade shares and contracts in bulk.

Plus, the above example took place in what's essentially a lab environment, where we assumed the dividend payout was the only factor moving the stock and option prices. A major broad-market swing, overnight news for the stock, a huge shift in implied volatility, delays in filling the buy and sell orders, or even the risk of early assignment can all play havoc with a dividend capture.

As a result, many retail-level traders opt against arbitrage strategies like the dividend capture. Regardless, it's worth knowing what this trade looks like and how it's played. Not only do dividend payments have a notable impact on stock and option prices, but -- as we've just discussed -- ex-div dates can also exert a remarkable influence on option activity.