Dividend Captures for Fun and Profit

NEW YORK (TheStreet) -- Not long ago the ability to capture dividends wasn't a realistic strategy for retail investors. Transaction costs, limited option liquidity, and a lack of reliable information kept everyone but a few marketmakers away. The situation has mostly changed, with the exception of reliable information.

Finding deep in-the-money call options to hedge a position with enough premium to justify the downside risk, is all but impossible. What investors can do however is find reasonable risk vs. reward setups to exploit for profit.

In the age of computers and automated trading, what keeps the strategy alive is the inability to scale. The inability to scale allows the retail investor continued opportunity.

I present these companies with potential dividend captures along with absolute minimum entry set up requirements needed. Ideally, having the discipline to demand even higher time value premiums will result in superior results.

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 amount needed over intrinsic value.

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.

UTX Dividend Chart UTX Dividend data by YCharts

United Technologies (UTX)

Background: United Technologies provides a broad range of high-technology products and services to the building systems and aerospace industries. Those products include Pratt & Whitney aircraft engines, space propulsion systems and industrial gas turbines; Carrier heating, air conditioning and refrigeration; Otis elevator, escalator and people movers; Hamilton Sundstrand aerospace and industrial products; Sikorsky helicopters and International Fuel Cells power systems. The company was founded in 1934 and is based in Hartford, Conn. United Technologies trades an average of 4.2 million shares per day with a marketcap of $70 billion.

Yield: 2.8%

Dividend Amount: 54 (53.5) cents

Ex-Dividend Date: Nov. 14 Beta: 1.05

Strategy:United Technologies offers us two different strategies. The first is to buy United Technologies stock and offer to sell the November $77.50 strike or lower call for $1.05 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 near 81 cents, plus dividend.

If my shares are called away before trading ex-dividend (resulting from the option buyer wanting the dividend), I gain about $1.05. The most I can make is $1.59 if I hold the covered call through option expiration day and the stock gets called away.

The second strategy is more conservative and results in a faster bang for your buck. If you trade with a broker that charges very little or nothing for exercises, the second strategy becomes even more favorable. Buy United Technologies stock and offer to sell the November $75 strike or lower call for 40 cents over the intrinsic value.

As long as the stock remains above the strike price the day before trading ex-dividend, you can expect assignment of your shares. The profitability is 40 cents, however, your risk is lower and the trade only lasts for about two weeks.

UTX Payout Ratio TTM Chart UTX Payout Ratio TTM data by YCharts

LLTC Dividend Chart LLTC Dividend data by YCharts

Linear Technology (LLTC)

Background: Linear Technology, together with its subsidiaries, designs, manufactures, and markets various analog integrated circuits worldwide. The company produces power management, data conversion, signal conditioning, µModule subsystems, and wireless sensor network products, as well as radio frequency and interface ICs. The company was founded in 1981 and is headquartered in Milpitas, Calif.. Linear Technology trades an average of 2.2 million shares per day with a marketcap of $7.4 billion.

Yield: 3.2%

Dividend Amount: 25 cents

Ex-Dividend Date: Nov. 14 Beta: 1.09

Strategy:Buy stock and offer to sell the November $31.00 strike or lower call for 35 cents over the intrinsic value as long as the stock remains above $31.10.

I will attempt to close out the trade with a gain of near 10 cents, plus dividend. If my shares are called away before trading ex-dividend (resulting from the option buyer wanting the dividend), I gain about 32 cents. The most I can make is 57 cents if I hold the covered call through option expiration day and the stock gets called away.

LLTC Payout Ratio TTM Chart LLTC Payout Ratio TTM data by YCharts

IP Dividend Chart IP Dividend data by YCharts

International Paper (IP)

Background: International Paper operates as a paper and packaging company in North America, Europe, Latin America, Russia, Asia, and north Africa. The company's Industrial Packaging segment manufactures containerboards, including linerboard, medium, whitetop, recycled linerboard, recycled medium and saturating kraft. The company was founded in 1898 and is based in Memphis, Tenn. International Paper trades an average of 4.2 million shares per day with a marketcap of $16 billion.

Yield: 3.26%

Dividend Amount: 30 cents

Ex-Dividend Date: Nov. 13

Beta: 2.22

Strategy:Buy stock and offer to sell the November $33.00 strike or lower call for 45 cents over the intrinsic value.

I will attempt to close out the trade with a gain of near 13 cents, plus dividend. 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.

I don't want the option hedge unless the sale will provide at least the minimum 45 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 45 cents. The most I can make is 75 cents if I hold the covered call through option expiration day and the stock gets called away.

IP Payout Ratio TTM Chart IP Payout Ratio TTM data by YCharts

LLY Dividend Chart LLY Dividend data by YCharts

Eli Lilly (LLY)

Background: Eli Lilly discovers, develops, manufactures, and sells pharmaceutical products worldwide. The company's neuroscience products treat schizophrenia, mixed/manic episodes, and bipolar maintenance; depression, diabetic peripheral neuropathic pain, anxiety disorders, fibromyalgia and chronic musculoskeletal pain; attention-deficit hyperactivity disorders; obsessive-compulsive and panic disorders and bulimia nervosa; and bipolar and treatment-resistant depression. The company was founded in 1876 and is headquartered in Indianapolis, Ind. Eli Lilly trades an average of 8.3 million shares per day with a marketcap of $56 billion.

Yield: 3.78%

Dividend Amount: 49 cents

Ex-Dividend Date: Nov. 13

Beta: 0.67

Strategy:Buy stock and offer to sell the November $49.00 strike or lower call for 30 cents over the intrinsic value.

The option will likely get exercised early for a gain of 30 cents the day before trading ex-dividend. The amount of profit (as a yield rate) for the holding period makes this strategy superior to actually capturing the dividend and holding for another week or more.

LLY Payout Ratio TTM Chart LLY Payout Ratio TTM data by YCharts

EXC Dividend Chart EXC Dividend data by YCharts

Exelon (EXC)

Background: Exelon is a utility holding company. Its subsidiaries are engaged principally in the production, purchase, transmission, distribution and sale of electricity to residential, commercial, industrial and wholesale customers and the distribution and sale of natural gas to residential, commercial and industrial customers. Exelon is a bold, creative, accountable and committed company, with employees dedicated in their efforts to set the standards for the utility services industry. The company was founded in 1887 and is headquartered in Chicago, Ill. Exelon trades an average of 5.7 million shares per day with a marketcap of $30 billion.

Yield: 5.79%

Dividend Amount: 53 cents

Ex-Dividend Date: Nov. 13

Beta: 0.51

Strategy: The first strategy is the standard dividend capture, but a superior strategy for investors bullish with Exelon follows after. Buy stock and offer to sell the November $35.00 strike or lower call for 26 cents over the intrinsic value.

Large yield stocks like Exelon, at 5.79%, often attract a lot of interest in dividend capturing so the option premium may be hard to get.

Don't enter into this trade unless the sale will provide at least the minimum 26 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 26 cents. The most I can make is 69 cents if I hold the covered call through option expiration day and the stock gets called away. This is unlikely and the odds favor having your shares called away first.

A better strategy is to buy the November $34 calls (maybe from someone who doesn't fully understand the market dynamics of price action before a large dividend stock is about to trade ex-dividend) for 5 cents above intrinsic value.

By buying the November $34 call, you're risk is a total of the option premium (for example $1.55 at the close Friday), and you have unlimited upside. The typical reason not to buy call options is all but non-existent with such a small time premium. In fact, you can expect to sell the option over a week later and receive the full time value back, or lose at the very most five cents.

Large dividend stocks tend to rise in front of their ex-dividend date. It's easy to understand why. Sellers are motivated to capture that last dividend, keeping their shares off the market, and investors are motivated to capture that first dividend. The result is a slight skewing of greater demand and lower supply. All else being equal, in the days before trading ex-dividend, expect the price to rise.

I use a proprietary blend of technical analysis, financial crowd behavior and fundamentals in my short-term trades, albeit not totally the same in longer swing trades to investments, the concepts used are similar. You may want to use this article as a starting point of your own research with your financial planner.

EXC Payout Ratio TTM Chart EXC Payout Ratio TTM data by YCharts

At the time of publication, the author held no positions in any of the stocks mentioned.

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