How to Use Dividend Capture Strategy

In this article you will know how to use dividend capture strategy. The dividend capture strategy technique is a strategy for trading stocks that focuses on generating income and is popular among day traders. Active trading is a strategy that requires frequent buying and selling of shares, holding them for only a short period of time–just long enough to capture the dividend the stock pays. This is in contrast to more traditional methods, which focus on purchasing and holding dividend-paying stocks for an extended period of time in order to generate a consistent income stream. Active trading is a strategy that requires frequent buying and selling of shares. Sometimes holding on to the underlying stock for just one day was all that was required.

The payment of dividends typically occurs once per year or once every three months; however, some dividends are given regularly. Traders that employ the dividend capture technique have a preference for annual dividend payouts that are higher in quantity since it is typically simpler to turn a profit employing the strategy when the dividend amounts are higher. About a variety of financial websites, you can get dividend calendars that include information on dividend payouts. You can access this information for free.

Continue reading if you are interested in learning more about the dividend capture technique. This article will also address some of the tax consequences and other considerations that investors should consider before incorporating this method into their investment plans. These are all topics that will be covered in this post.

Dividend Timeline

Four important dates are at the heart of the dividend capture strategy:

• The date of declaration is when the board of directors will announce the distribution of dividends. This is the date on which the dividend is officially announced by the corporation. It takes place a significant amount of time before the payment.
• Ex-dividend date (or ex-date): The dividend is not included in the initial trading price of the share. This is the last day that you can be considered for the dividend payment in order to be qualified. It is also the day when the stock price often falls in accordance with the amount of dividends that have been declared. The stock must have been purchased by the traders before this crucial day.
• Date of the document: All stockholders currently on record will be eligible to receive a dividend. On this day, a corporation will record which shareholders are entitled to receive the dividend and send it out to those shareholders.
• Pay date: This is the day on which the dividend is paid out, as well as the day on which the corporation issues dividend payments.

How Does the Strategy Work?

The dividend capture method is appealing since it requires no extensive fundamental research or charting. Essentially, an investor or trader buys stock before the ex-dividend date and sells it on the ex-dividend day or at any time thereafter. If the share price falls following the dividend announcement, the investor may decide to wait until the price returns to its former level. To get the dividend payment, investors do not need to keep the stock until the pay date.

The dividend capture method should not work in theory. If markets followed perfect logic, the dividend amount would be precisely reflected in the share price until the ex-dividend date, at which point the stock price would decline by the dividend amount. It doesn’t normally happen that way since markets don’t operate with such precise precision. Typically, a trader captures a significant percentage of the dividend despite selling the shares at a minor loss after the ex-dividend date. A simple example would be a stock trading at $20 per share, paying a $1 dividend, and decreasing in price on the ex-date only to $19.50, allowing a trader to earn a net profit of $0.50, capturing half of the dividend in profit.

Using Options Contracts

A more advanced dividend capture technique entails attempting to collect more of the full dividend amount by buying or selling options that should profit from the fall in the stock price on the ex-date.

Because at least one stock pays dividends practically every trading day, the dividend capture strategy provides ongoing profit chances. A substantial investment in one company can be rolled over into new positions on a regular basis, capturing the dividend at each stage along the way. Investors can benefit from small and big yields with a significant initial capital commitment because rewards from successful implementations are compounded often. Though it is typically preferable to concentrate on mid-yielding (3%+) large-cap enterprises in order to reduce the risks associated with smaller companies while still achieving a significant dividend.

Traders utilizing this technique consider harvesting dividends from high-yielding international equities that trade on U.S. exchanges as well as dividend-paying exchange-traded funds in addition to the highest dividend-paying traditional stocks.

Actual-Life Illustration

As an example of dividend capture in the past, on April 27, 2011, shares of Coca-Cola (KO) were trading at $66.52. The next day, on April 28, the board of directors declared a regular quarterly dividend of $0.47 cents, and the stock increased from $0.41 cents to $66.93.

Although theory would predict that the price increase would equal the whole amount of the dividend, general market volatility plays a substantial impact in the stock’s price effect. Six weeks later, on June 10, the company’s stock price was $64.94. This is the day the dividend capture investor would buy the KO shares.

The dividend was declared on June 13, and the share price increased to $65.12.
This would be a great exit opportunity for the trader, as he would not only be eligible for the dividend but would also make a capital gain. Unfortunately, in the equities markets, this type of circumstance is not common. Instead, it underpins the strategy’s overall idea.

Dividend Capture Strategy and Their Tax Implications

Qualified dividends are taxed at 0%, 15%, or 20% of the investor’s total taxable income.

Dividends collected through a short-term capture technique do not meet the required holding criteria for preferential tax treatment and are taxed at the investor’s regular income tax rate. To be eligible for the preferential tax rates, the Internal Revenue Service (IRS) states that “you must have held the stock for more than 60 days throughout the 121-day period beginning 60 days before the ex-dividend date.”

Taxes significantly reduce the possible net benefit of the dividend capture approach. It is crucial to remember, however, that if the capture method is used in an IRA trading account, an investor can avoid paying dividend taxes.

Additional Costs Involved With Dividend Capture Strategy

Transaction costs further decrease the sum of realized returns. Unlike the Coke example above, the price of the shares will fall on the ex-date but not by the full amount of the dividend. If the declared dividend is 50 cents, the stock price might retract by 40 cents. Excluding taxes from the equation, only 10 cents is realized per share. When transaction costs to purchase and sell the securities amount to $25 both ways, a substantial amount of stocks must be purchased simply to cover brokerage fees. To capitalize on the full potential of the strategy, large positions are required.

The potential gains from a pure dividend capture strategy are typically small, while possible losses can be considerable if a negative market movement occurs within the holding period. A drop in stock value on the ex-date which exceeds the amount of the dividend may force the investor to maintain the position for an extended period of time, introducing systematic and company-specific risk into the strategy. Adverse market movements can quickly eliminate any potential gains from this dividend capture approach. In order to minimize these risks, the strategy should be focused on the short-term holdings of large blue-chip companies.

Investors who are looking for a steady income can benefit from using dividend capture strategies, which offer an alternate investment approach. The dividend capture technique is criticized by proponents of the efficient market theory, who argue that it does not produce desirable results. This may be due to the fact that investors anticipate a gain in stock prices equal to the amount of the dividend as the declaration date approaches, or it may be due to the fact that market volatility, taxes, and transaction expenses reduce the likelihood of finding risk-free profits. On the other hand, agile portfolio managers will frequently and successfully use this strategy as a means of earning quick profits on their investments.

Summery

• A timing-oriented approach to investing, a dividend capture strategy involves strategically timing the purchase of dividend-paying companies and then selling those equities at the optimal time.
• The strategy known as dividend capture involves purchasing a stock shortly before the ex-dividend date in order to be eligible for the dividend, and then selling the stock as soon as the dividend is paid out.
• As opposed to being an investment for the longer term, the two trades’ sole objective is to collect the dividends that are due to them.
• The efficacy of this method has been called into doubt due to the fact that markets have a tendency to be somewhat efficient and equities typically decrease in value immediately following the ex-dividend date.

Reference – Internal Revenue Service.”Publication 17: Tax Guide 2019 for Individuals

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