Today, I’m going to take a slight turn off the track of buying and selling companies for no money down and share about what to do with the wealth you’ll generate from doing these deals.
Now, I’m not a licensed investment professional, but a strategy that I’ve been playing with—and doing very well with—is called dividend capture. It’s actually not a particularly original idea, but it is a popular one.
What Is Dividend Capture?
A dividend capture is a stock trading strategy that’s focuses on getting you income. Unlike the more traditional approaches, here you’re buying and selling shares and holding them for a short period of time. You’re basically buying a stock the day it goes ex-dividend so you can receive the dividend.
When you buy stocks and shares, the exchange automatically adjusts the price on the stock. It adjusts the market cap of the company by the amount of the dividend that’s been issued. The logic behind that is if cash is going to be given back to investors, it should come straight off the valuation.
With this kind of elementary brushstroke approach to price reduction, what tends to happen is certain really good quality stocks tend to recover much quicker. You will find that there are stocks that you can buy when they go ex-dividend. When they are “ex-dividend,” you’re trading stock without the value of the dividend payment.
One to two days after the ex-dividend date, they are back to the same price as they were before. The drop in price signals a lot of people to buy them and then the price just naturally reverts. The logic is that if you buy it just before ex dividend, you can capture the dividend.
Receiving Dividends and Premiums
When that happens, you get paid the dividend on the stock, and then you can sell it again when the price recovers and you harvest the dividend amount. You’ll get your cash back so you’re able to do another and another. You’re basically constantly recycling.
That idea has been around a while and many people do it. But the slight twist that I use on this strategy is also selling a covered call option on the stock that you end up buying. With a covered call, you’re selling the right to sell the security to someone else for cash. The investor selling call options can then generate an extra income.
Effectively, you buy the share the day before it goes ex dividend. That means you’ve captured the dividend on the stock. I then sell the covered call on the share so that when it recovers back to the price, it’s automatically sold under that option.
In this case, a covered call on the share harvests that extra little bit of premium because when you sell it on shares that you already own, you receive an upfront premium.
Applying This Strategy to Blue Chip Companies
If you look at some of the shares that I do this with regularly, with these typical blue chip stocks, such as Unilever, Procter and Gamble, and Pfizer, what you’ll find is that, because they pay a quarterly dividend, the actual dividend payout itself is fairly low.
You capture maybe half a percent on the dividend capture component. But remember you are only holding it for a few days. A half percent for a few days is not too bad. But by selling the covered call, you can often make a couple of percent on top.
That means you’re making 2 ½ percent for holding it only for a short time. Typically, the covered call options that are for sale expire in the middle of the month. So, if you’re buying something at the end of the month, you’re only holding it for two weeks, and you’re getting this 2 ½ to 3 percent return sometimes on that particular share.
The other interesting thing is that, through private wealth banking, you can do this using a little bit of leverage on your existing portfolio. You don’t actually have to commit any cash to be able to do it.
Because most of the shares that I’m talking about are these large blue-chip type of companies, they tend to have around a 70 percent loan to value from a leverage perspective. You only need to put 30 percent of the cash upfront.
To give you a better idea: when buying $100,000 worth of Microsoft, which is a common one that I do dividend capture on, you only need to put $30,000 into that transaction. The balance of $70,000 is provided by the bank at 0.7 percent a year in interest.
For an incredibly low rate of margin, you’re getting the 0.5 percent and the 2 percent, or 2.5 percent, for the covered call. Approximately 3 percent on $100,000 is $3,000. But you’ve only committed $30,000 of actual upfront kind of cash, which can be done in this leveraged way.
Fundamentally, your return is about 10 percent in that two-week period that you’re holding this option. The risk with this would be that there is a big market correction during the time that you’re holding the share.
This is why we like the dividend.com selections: we cross-reference those dividend.com selections with the Julius Baer recommended list. (If you go to the famous website dividend.com as a premium member, you can see a list of dividend capture stocks.)
From the big list that you get on dividend.com, it becomes a small list of big blue-chip companies that you maybe wouldn’t mind owning in your portfolio in the long term anyway.
Because the dividends are paid quarterly, you can use this strategy four times a year. Effectively, there could be a correction at one of those four times over maybe several years but would you simply hold that stock until the market recovers in the future?
You would exit so the covered call wouldn’t get triggered because the price would never go back above the covered call rate.
On that basis, you can harvest 10 percent from cash invested every quarter from a particular stock. And after two weeks you have that money back in your account to be able to reinvest in the next one.
Look, I’m by no means a serious stock trader or investment guy, but what I quite like is that this is a strategy for a small percentage of your portfolio, just so you can do something a little bit more interesting.
That gives you exposure to equities without the traditional “just buy and hold” strategy of owning all these blue chips. You’ll have exposure to the blue chips and the upside from the dividend and the covered call to give you a decent return. This is potentially a bit more interesting than just traditional investing.
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