Dividend Arbitrage

What Is Dividend Arbitrage?

Dividend arbitrage is an options trading strategy that includes purchasing put options and an equivalent amount of underlying stock before its ex-dividend date and afterward exercising the put subsequent to collecting the dividend. At the point when utilized on a security with low volatility (causing lower options premiums) and a high dividend, dividend arbitrage can bring about an investor acknowledging profits while expecting extremely low to no risk.

Understanding Dividend Arbitrage

In the first place, a few fundamentals on arbitrage and dividend payouts. Generally talking, arbitrage exploits the price differences of indistinguishable or comparable financial instruments on various markets for profit. It exists because of market inefficiencies and wouldn't exist assuming the markets were all entirely efficient.

A stock's ex-dividend date (or ex-date for short), is a key date for figuring out which shareholders will be qualified for receive the dividend that is shortly to be paid out. It's one of four stages associated with dividend disbursal.

The first of these stages is the declaration date. This is the date on which the company declares that it will give a dividend later on.
The subsequent stage is the record date, which is the point at which the company examines its current rundown of shareholders to figure out who will receive dividends. Just the people who are registered as shareholders in the company's books as of the record date will be qualified for receive dividends.
The third stage is the ex-dividend date, normally set two business days prior to the record date.
The fourth and last stage is the payable date. Also known as the payment date, it marks when the dividend is really dispensed to eligible shareholders.

All in all, you must be a stock's shareholder of record on the record date as well as very it. Just those shareholders who owned their shares something like two full business days before the record date will be qualified for receive the dividend.

Following the ex-date, the price of a stock's shares typically declines by the amount of the dividend being issued.

Thus, in a dividend arbitrage play, a trader purchases the dividend-paying stock and put options in an equivalent amount before the ex-dividend date. The put options are deep in the money (that is, their strike price is over the current share price). The trader collects the dividend on the ex-dividend date and afterward exercises the put option to sell the stock at the put strike price.

Dividend arbitrage is expected to make a risk-free profit by hedging the downside of a dividend-paying stock while waiting for impending dividends to be issued. Assuming the stock drops in price when the dividend gets compensated — and it normally does — the puts that were purchased give protection. Thusly, buying a stock for its dividend income alone won't give similar outcomes as when combined with the purchasing of puts.

Dividend Arbitrage Example

To outline how dividend arbitrage functions, envision that stock XYZABC is currently trading at $50 per share and is paying a $2 dividend in multi week's time. A put option with an expiry of three weeks from now and a strike price of $60 is selling for $11. A trader wishing to structure a dividend arbitrage can purchase one contract for $1,100 and 100 shares for $5,000, for a total cost of $6,100. In multi week's time, the trader will collect the $200 in dividends and the put option to sell the stock for $6,000. The total earned from the dividend and stock sale is $6,200, for a profit of $100 before fees and taxes.

Highlights

Dividend arbitrage is expected to make a risk-free (or low-risk) profit by hedging the downside of a dividend-paying stock while waiting for impending dividends to be issued.
At the point when utilized on a security with low volatility (causing lower options premiums) and a high dividend, dividend arbitrage can bring about an investor acknowledging profits while expecting exceptionally low to no risk.
Dividend arbitrage is an options trading strategy that includes purchasing put options and an equivalent amount of underlying stock before its ex-dividend date and afterward exercising the put subsequent to collecting the dividend.