Capturing Lowe's Fat Dividend With Options

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 to this strategy.

The most important requirement for receiving a stock's dividend is to be a shareholder on the stated day of record.

There is no free lunch on Wall Street, but if you get up early enough sometimes you can get a free breakfast. My method can be used to capture multiple dividends by holding a stock and its related options for more than three months.

Theta (the time decay of an option premium) is the best friend of option sellers, but it's the worst enemy of buyers.

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, because higher-yielding options have lower-time premiums, all else being equal.

Also, the longer I maintain a covered-call position (for example, two weeks with a front-month option, for example) the less 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 even if it does, the trade can still be 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.

Lowe's Companies Inc. ( LOW) is a leading home-improvement retailer that targets both do-it-yourself consumers and business customers. The company was founded in 1946 and is based in Mooresville, N.C.

Yield: 2.25%

Dividend Amount: 16 cents

July 23, 2012

Beta: 1.04

Strategy: Buy Lowe's Companies stock and offer to sell the August $26.00 strike or lower call for 26 cents over the intrinsic value. I will attempt to close out the trade with a gain of about 18 cents, plus dividend.

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 26 cents over intrinsic value.

Real Money Pro's Gary Morrow wrote an interesting article about Lowes' valuation titled "Lowe's Appears Vulnerable. (You need a Real Money Pro subscription, but if you don't have one, try the free trial offer so you can read it.)

If my shares are called away before trading ex-dividend (resulting from the option buyer wanting the dividend), I gain about 26 cents. The most I can make is 42 cents if I hold the covered call through option expiration and the stock gets called away.

TheStreet's Jim Cramer recently took a look at why low-end retail is winning over luxury. You can read this blog entry for free in this past week's Jim Cramer's Best Blogs.

Cramer discusses Costco ( COST), Wal-Mart Stores ( WMT) and Home Depot ( HD) as the low-end stocks that are doing well.

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.

Lowe's makes a good candidate for multiple dividend captures or as a hold for appreciation. Lowe's trades at a discount to and operates at better margins than Wal-Mart, Costco, Lumber Liquidators Holdings ( LL), and Builders FirstSource Inc. ( BLDR).

I use a proprietary blend of technical analysis, financial crowd behavior and fundamental analysis in my short-term trades. You may want to use this article as a starting point for your own research with your financial planner.

At the time of publication, the author held no shares of stocks mentioned.

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