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Buying GM or Huntsman? Know Your Options

Stocks in this article: GM HUN

NEW YORK (TheStreet) -- Have you heard of dividend-capturing strategies? It's a two-part strategy based on dividend distributions.

An investor times the purchase of a stock before the ex-dividend date and owns it for as little as one day. The subsequent part is selling said stock for at least as much as what you paid for it. It's not easy to do and price fluctuations can make it downright unprofitable. In theory, a stock should open up on the ex-dividend date lower than the previous day's close by an amount equal to the dividend.

Options are often used in an attempt to mitigate price fluctuation risk. An investor wanting to hedge against a price decline may sell a deep-in-the-money call hoping the option will move in lockstep with the underlying stock price. Unfortunately, dividends are priced into options, making it difficult to find an option with enough time premium that the buyer won't be motivated to exercise before the ex-dividend date.

Another approach is to take the other side and buy a cheap call option for a stock you already want to buy. If you already want to buy a stock that is highly liquid -- meaning it trades at least a million shares a day -- and also pays a dividend, it pays to check the stock options to see if it's advantageous to gain exposure through an option instead of the stock.

Take General Motors (GM) as an example. GM's next expected dividend payment is 30 cents, and the next ex-dividend date is March 14. At $36.60 a share, the annualized yield is about 3.25%.

An investor can buy the shares for $36.70 and assume the full risk of the position or as an alternative, buy a March $33 strike call for about $3.70. The call will move up almost perfectly with the stock and down at a sliding scale rate. In other words, you receive all the upside potential, but if GM drops $3 tomorrow, the option may only lose $2.10.

The option doesn't expire until March 21 but the ex-dividend date is March 14, so if the option is in-the-money, it may be in the option owner's best interest to exercise or sell the option on March 13. Maybe you're not interested in owning the stock but are hoping to profit from stock appreciation into an ex-dividend date.

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