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trading dividends

When a stock pays a dividend the amount of the dividend is subtracted from the price of the stock.

For example, if XYZ stock is trading at $100, it will trade at $99 after paying a $1 dividend. Empirical evidence shows that when a stock goes ex-dividend, the stock usually trades above it's ex-dividend price. A $100 stock that pays a $1 dividend will trade above $99 at the open most of the time.

Profiting from this requires that the stock is purchased at the close of trading the day before a stock goes ex-dividend. The stock must be sold the following day, the ex-dividend day, immediately at the open.
Just how much can be made by trading dividends depends on how much the stock trades above the ex-dividend on the open. Statistically, stocks paying more than 3% annualized lose only 72% of their dividend value when the market opens on the ex-dividend date.

Consider $100,000 worth of stock paying a quarterly dividend with a 4% annual yield. A quarterly dividend payment would equal $1000. Theoretically, the value of this stock would drop to $99,000.

If this stock loses only 72% of it's dividend value, the value of the stock would drop to $99,280. The holder of the stock would incur a capital loss of $720, then receive $1000 on the dividend pay date, for a net profit of $280.

The cost of the round trip trade must be deducted from the transaction, and that would diminish the overall return.

A significant benefit of trading dividends is the potential tax benefit. Dividend income is taxed at 15%, while the capital loss incurred can be deducted at the marginal tax rate. This rate varies depending on your tax bracket. A taxpayer subject to a 33% marginal tax rate would have the added benefit of paying a tax rate reduced by 18% on the $1000 dividend.

In the above example trade, the immediate benefit would be $280 less commissions, and the deferred benefit would be 18% of $720. Although this return on investment may appear small, the benefit can be realized frequently, and the aggregate of these trades can be significant.

Disadvantages of trading dividends are:

The advantages are:

There are guidelines for trading dividends:



Data Provided by HistoricalOptionData.com
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