Security Futures Tied to Dividend Whipping Post

Effects on Security Futures

Taxes affect behavior and create trading opportunities. As I'm sure many of you have done as well, I've tried wherever possible to stuff my tax-advantaged accounts with higher-yielding instruments. If the dividend tax is in fact eliminated -- the betting here is that it will be reduced, but not eliminated entirely -- then putting high-yielding stocks in a 401K or an IRA is as irrational as putting municipal bonds therein.

At zero taxation, and if we add in the increase in cost basis that will serve to reduce capital gains taxes (retained earnings not paid as dividends will be added to the per-share cost basis), dividends will have an advantage with respect to both bond interest and capital gains. This may not be as socially upsetting as changing the rules of poker so that two pair now beats three of a kind, but it's of the same magnitude. You'll have to learn new ways of thinking, and who wants that?

The still-new business of single-stock futures will be affected, as well. The price of a stock future is the price of the stock plus the interest rate cost of carry minus the future value of the expected dividend. If the dividend yield is higher than the short-term interest rate, as is almost always the case at today's 1.20% T-bill rates, then the single-stock future will trade at a discount to the stock. This discount accrues to the capital gain or loss on the stock until expiration.

At the one-year horizon, where interest rates are close to 1.5%, we should expect to see the futures of stocks yielding more than 1.5% trading at the discounts represented in the chart below.

Fair Value Multiplier at One-Year Horizon High dividend

Source: Bloomberg

Stocks that don't pay a dividend at all or whose yield is less than 1.5% will see their future trading at a premium to the stock.

Fair Value Multiplier at One-Year Horizon Low or zero dividend

Source: Bloomberg

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