Quarterly dividend payments are a nice treat to reward blue chip stock investors for their patience and loyalty. In the long-term, dividend yields of 3 percent or higher can make a meaningful impact on portfolio returns as well, especially while interest rates remain historically low.
However, certain traders don’t want to wait three months to get their next dividend payout. Here’s a look at how dividend capture traders get paid as often as they can.
Dividend capture traders attempt to enter and exit dividend paying stocks as quickly as possible and still receive the dividend. If the general idea sounds too good to be true, there are definitely caveats to the strategy. Future dividends are priced into any dividend-paying stock’s current share price. Therefore, as soon as a company has committed to paying out the dividend, its share price theoretically adjusts downward to reflect the lost dividend value.
However, in reality, the stock’s adjustment may not be perfectly efficient, leaving a small window of opportunity for dividend capture traders.
Here’s how the dividend capture trade works. Traders buy a stock prior to the close on the day prior to a company’s ex-dividend date. The ex-dividend date is the date on which an investor must be a shareholder of record to receive the next dividend payment.
On the ex-dividend date, these stocks tend to open down as the market adjusts for the fact that the stock is “excluding the dividend” for new buyers. However, dividend capture traders can take advantage of two phenomena that occur on the ex-dividend date.
First, the market adjustment often does not reflect the full value of the dividend payment. For example, a stock that pays a 4 percent annual dividend yield should theoretically open down 1 percent on each of its four ex-dividend dates throughout the year. If the stock instead initially opens down 0.7 percent, dividend capture traders can profit from this market inefficiency.
The other scenario is that the dividend stock initially opens down 1 percent, but quickly rebounds, providing another potential window of opportunity for traders to sell. These high-yield dividend stocks are often well-established blue chip companies. These companies routinely experience a flood of buying volume on any pullback, including those that happen on ex-dividend dates. When dip buyers swoop in, dividend capture traders take advantage of the rebound by cashing out.
The primary downside of using a dividend capture trading strategy is the extremely thin profit margins the trades generate. In the example above, the hypothetical trade would result in a gain of 0.3 percent. However, that gain doesn’t factor in trading commissions and non-qualified dividend tax rates, which are typically equal to an investor’s ordinary income tax rate.
In other words, trades may need to place extremely large orders to make narrow-margin dividend capture trades worthwhile. And of course, larger trades come with their own set of risks, as there’s no guarantee the dividend payment will be the only catalyst impacting a stock’s share price on the ex-dividend date.
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