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.

Corrections Corp Of America (CXW)

Corrections Corporation of America, together with its subsidiaries, owns and operates privatized correctional and detention facilities.

Yield: 2.88%
Dividend Amount: $0.20
Ex-Dividend Date: June 06, 2012
Beta: 0.91

Strategy: Buy Corrections Corp Of America stock and offer to sell the June $25.00 strike or lower call for 32 cents over the 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 32 cents. The most I can make is 52 cents if I hold the covered call through option expiration day and the stock gets called away.

After qualifying for the dividend, I will attempt to close out the trade with a gain of near 14 cents, plus the dividend earned.

The Travelers Companies, Inc. (TRV)

The company was founded in 1853 and is based in New York City.

Yield: 2.85%
Dividend Amount: $0.46
Ex-Dividend Date: June 06, 2012
Beta: 0.68

Strategy: If you are bullish with The Travelers Buy the June $60.00 strike call for 20 cents over the intrinsic value. The Travelers doesn't trade ex-dividend for almost three weeks. Expected time decay is less than 15 cents. For less than a penny a day you can gain exposure to The Travelers with a maximum risk of about $4.50. If the wheels fall of Europe and the markets fall apart, buying the call options limits your risk to less than a 10% downward move compared to buying the stock outright.

Kohl's Corporation (KSS)

Kohl's Corporation operates department stores in the United States. The company was founded in 1962 and is headquartered in Menomonee Falls, Wis.

Yield: 2.66%
Dividend Amount: $0.32
Ex-Dividend Date: June 04, 2012
Beta: 0.85

Strategy:

Buy Kohl's stock and offer to sell the June $46.00 strike or lower call for 50 cents over the 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 50 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.

Occidental Petroleum Corporation (OXY)

Occidental Petroleum Corporation engages in the exploration and production of oil and gas properties in the U.S. and internationally. The company operates in three segments: Oil and Gas; Chemical; and Midstream, Marketing, and Other. The company was founded in 1920 and is headquartered in Los Angeles, Calif.

Yield: 2.58%
Dividend Amount: $0.54
Ex-Dividend Date: June 06, 2012
Beta: 1.16

Strategy:

Buy Occidental Petroleum stock and offer to sell the June $75 strike call for $1 over the intrinsic value. For a more aggressive approach sell the June $80 strike call for $2.85 over the intrinsic value. Occidental appears oversold based on technical analysis. While I am long-term bearish oil, I believe the odds favor a bounce higher for Occidental.

If my shares are called away the day before trading ex-dividend (resulting from the option buyer wanting the dividend), I gain about $1 with the $75 strike and $2.85 with an $80 strike.
At the time of publication, the author held no positions in any of the stocks mentioned.

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