Buying GM or Huntsman? Know Your Options

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.

As the clock moves towards the option expiration date, as long as it's in the money, the option delta (the amount the option price moves in relation to the stock price) will tend to increase. If you're already going to buy GM, for an extra 10 cents in option premium (that you may get if/when you sell) will limit your potential loss to $3.80.

Another advantage for investors using margin is the ability to control over nine times as many shares without paying interest for margin. I'm not suggesting someone should hit it with both barrels. I'm simply pointing out options offer a means to deleverage relative to owning the stock.

Another example is Huntsman (HUN). Investors buying the stock have $24.63 of exposure, but through options it's possible to significantly lower risk -- at least until the day before ex-dividend.

Huntsman trades ex-dividend on March 12 and is expected to pay 12.50 cents for a yield of 2%. Instead of buying shares at $24.63, an alternative is buying March $22 calls for about $2.75.

For about 11 cents in time premium, an investor can receive all the upside potential, while only risking about 12% compared to buying the stock. Since some time premium should remain on March 11, the total time premium cost of ownership is more likely 5 cents or less.

Regardless, it's a small premium in light of the risk savings. Next time you're shopping for a dividend-paying stock be sure to review the options to see if they're your best option.

At the time of publication, Weinstein had no positions in securities mentioned.

Follow @RobertWeinstein

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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