High-Liquidity Dividend Captures: Independence Day Edition

NEW YORK ( TheStreet) -- Dividend capturing is relatively new to the retail investor. Before the Internet, transaction costs, limited option liquidity and lack of information created barriers, preventing investors from exploiting this market edge. The most important requirement to receive a dividend is to be a shareholder on the required day of record.

Like most investing, there is no free lunch on Wall Street. At the same time, dividend capturing survives, due to the inability to scale very well. This method can be used to capture multiple dividends by holding the stock and option longer than three months.

For writers of options, Theta (time decay of option premium) is their best friend, and for buyers, the worst enemy. Options are a decaying asset much like milk, and using an option hedge while holding a stock can be profitable, even if the stock doesn't move higher. This is especially true in higher-yielding stocks, since higher-yield options have lower-time premiums, all else being equal.

Also, the longer I maintain a covered-call position (like two weeks with a front-month option, for example) the lower the time premium is worth (all else being equal).

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 is profitable if everything is done according to plan).

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

The following four stocks have a lot in common. They all have unusually large option volume/premium. There's no struggle to find hedges, as the large liquidity of these option hedges makes it easy to enter into the trades. Also, they all go ex-dividend the same week of July 4.

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American Express Company (AXP)

American Express is primarily engaged in the business of providing travel-related services, financial advisory services and international banking services; it is headquartered in New York city.

Yield: 1.43%
Dividend Amount: 20 cents
Ex-Dividend Date: July 3, 2012
Beta: 1.82

Strategy: Buy American Express stock and offer to sell the July $50.00 strike or lower call for 58 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 look to close out the covered option with a gain of about 41 cents, plus dividend.

With the yield of American Express at only 1.43%, as much or more of the gain should be coming from the option premium; otherwise it does not make sense to try to execute this trade.

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 58 cents over intrinsic value.

If my shares are called away before trading ex-dividend (resulting from the option buyer wanting the dividend), I gain about 58 cents. The most I can make is 78 cents, if I hold the covered call through option expiration day and the stock gets called away.

Here is a look at American Express with others in the industry:

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Monsanto Company (MON)

Monsanto is a leading global provider of technology-based solutions and agricultural products and is headquartered in St. Louis, MO.

Yield: 1.51%
Dividend Amount: 30 cents
Ex-Dividend Date: July 03, 2012
Beta: 0.91

Strategy: Buy Monsanto stock and offer to sell the July $75.00 strike or lower call for $1.75 over the intrinsic value.

I will look to close out the covered option with a gain of about 63.96 cents, plus dividend. The most I can make is $2.05, if I hold the covered call through option expiration day and the stock gets called away.

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Lincoln National Corporation (LNC)

Lincoln National is a holding company. Through subsidiary companies, Lincoln operates multiple insurance and investment management businesses. The company was founded in 1904 and is headquartered in Radnor, PA.

Yield: 1.53%
Dividend Amount: 8 cents
Ex-Dividend Date: July 06, 2012
Beta: 2.63

Strategy: Buy Lincoln National and offer to sell the July $18.00 strike or lower call for 52 cents over the intrinsic value.

I will look to close out the covered option with a gain of about 18 cents, plus dividend. The most I can make is 60 cents, if I hold the covered call through option expiration day and the stock gets called away.

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JPMorgan Chase (JPM)

JPMorgan Chase & Co. is a leading global financial services firm and is headquartered in New York city.

Yield: 3.56%
Dividend Amount: 30 cents
Ex-Dividend Date: July 03, 2012
Beta: 1.32

Strategy: Buy JPMorgan stock and offer to sell the July $26.00 strike or lower call for 39 cents over the intrinsic value.

I will attempt to close out the trade with a gain of near 12 cents, plus dividend. The most I can make is 69 cents, if I hold the covered call through option expiration day and the stock gets called away.

DISCLOSURE: At the time of publication, Weinstein held no positions in stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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