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5 Dividend-Captures With Option Trades

NEW YORK (TheStreet) -- Using options with dividend paying stocks is a powerful way to mitigate risk, while stepping in front of an upcoming dividend. Let's review stocks worth investing in offering dividends.

I am interested in dividend capturing primarily for the dividend, but there is also a chance the price could fall enough that I end up owning it for longer than planned. As a result, I must be sure this is a company I wouldn't mind holding for a while. Assuming I am not willing to own a dividend-paying company if the price falls, I pass and move on to one I will be happy holding, knowing that if the shares fall in price, I will be comfortable owning shares for a longer period.

Automatic Data Processing (ADP)

Automatic Data Processing provides business-outsourcing solutions. The company operates in three segments: Employer Services, Professional Employer Organization (PEO) Services and Dealer Services. The company was founded in 1949 and is headquartered in Roseland, New Jersey.

Yield: 2.94%
Dividend Amount: $0.40
Ex-Dividend Date: June 06, 2012
Beta: 0.69

Strategy:

Buy Automatic Data Processing stock and offer to sell the June $52.50 strike or lower call for 42 cents over the intrinsic value.

The option may get exercised early for a gain. In almost all cases, I sell the call option first to ensure the stock option leg is complete. If not, after qualifying for the dividend, I will attempt to close out the trade with a gain of near 12 cents, plus the dividend earned.

I review many call strikes and estimate the expected probabilities based in part on beta, bid, offer and volume traded the current day, open interest, and time value/implied volatility. Call options offer some protection from possible adverse moves in the stock price and provide offset revenue when the options do not fully cover down moves in the stock. Income is welcomed, but not needed from option premiums, so a break even from option premiums received/stock losses ratio is a win.

When learning a new trading strategy it is better to use a simulated trading account first. Stockpickr is a great tool to practice new strategies and learning about the market. I use Stockpickr and recommend it. It is easy to make mistakes when starting out on a new strategy and mistakes cost a lot less with a simulated account. After a level of confidence is built, then it may be time to move into a real money account.

Automatic Data Processing upcoming stock dividend appears to be attractive and worth the time and effort to capture. A requirement I have is to be able to sell a call option in either the front, or first back month that is in the money, and with enough premium that I will not object to an early exercise notice (which does happen from time to time, but profitable if everything is done according to plan).

It is important to sell the call option hedge at or near the asking price for at least the minimum amount over intrinsic value. I don't want the option hedge unless the sale will provide at least the minimum 42 cents over intrinsic value.

If my shares are called away the day before trading ex-dividend (resulting from the option buyer wanting the dividend), I gain about 42 cents. The most I can make is 82 cents if I hold the covered call through option expiration day and the stock gets called away.

My last step (completed before making a trade on the same day) is to check company announcements, and news sources for possible events that may cause the stock price to move. This is especially critical during earnings season.

Stock quotes in this article: ADP, CXW, TRV, KSS, OXY 

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