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Ric Cox

pro MEMBER SINCE 2018

Richard has more than two decades of experience in the financial markets and has had his writing appear on CNBC, NASDAQ, Economy Watch, Motley Fool, and Wired Magazine

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15 min read 26th of Jun, 2018
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Dividend Capture Strategy Tutorial

Dividend capture is a financial market strategy that involves timing-oriented trades of stable stocks that pay dividends.  In practice, a dividend capture strategy requires an investor to buy shares of stock just before its ex-dividend date.  This allows an investor to “capture” the dividend and then immediately sell the stock once the dividend payment is made.  In many cases, the shares of the underlying stock are held for just a single day.

The capture strategy is a two-trade system that is solely designed to allow investors to benefit from a stock’s dividend without encountering the risks involved when holding shares for an extended period of time.  In any market investment, the longer an asset is held, the greater the potential it has to fall in value.  This is a fact that creates additional benefits from market positions that are held for a short period of time.  Unlike most traditional trades in equities (where a stock is held until its share price generates a profit), the central purpose of the dividend capture strategy is to receive a dividend payment and quickly exit the position.

Dividend Benefits For Income Investors

Dividends offer a reliable source of revenue that allows many investors to generate consistent income from stock portfolio holdings.  Essentially, a dividend provides cash payments to stockholders in periodic time intervals (usually monthly, quarterly, or annually).  These dividend payments represent each stockholder’s share of current profits generated by the issuing company.

Many blue-chip dividend stocks are able to provide income investors with regular payments that are associated with relatively low risk metrics and limited price volatility in the underlying asset.  Dividend stocks usually offer higher investment yields when compared to guaranteed financial instruments (i.e. Treasury securities or CDs) and dividend payouts are made for as long as the stock position is held.  This is the reason many income investors will include dividend stocks as an integral part of a long-term retirement portfolio.  However, many day traders are only interested in holding a dividend stock long enough to receive the payout.  This short-term dividend strategy is what’s commonly referred to as the “dividend capture.”

Dividend Capture Risk Factors

Short-term traders use the dividend capture strategy as an easy, straightforward method of producing income with limited exposure to capital losses.  This is primarily due to the fact that each dividend stock position is only held for a short period of time.  However, it must be noted that trading exchanges often adjust a stock's share price on its ex-dividend date (by an amount that’s roughly equal to the upcoming dividend payout).  These are losses that can be recovered later, assuming the stock is able to trade back near its prior valuations.  But this potential for downside price movement on a stock’s ex-dividend date is an initial factor that can create early risks for traders.

Additionally, capital gains taxes and trading costs can inhibit profit potential when using the dividend capture approach.  This is the primary reason many corporations engage in these types of investment strategies.  Essentially, corporations often encounter limited tax liabilities for dividend income that is received from other corporations.  However, these benefits are not extended to individual traders and the elevated taxes associated with capital gains can be prohibitive for those attempting to achieve long-term returns.

Ultimately, dividend capture is very similar to the idea of “trading dividends.”  Some financial planners discourage individual clients from using this strategy because of the trading commissions, time management, and financial research required to achieve long-term profitability under this approach.  However, it should also be noted that many income-focused traders are able to outperform the major stock benchmarks when consistent methods of analysis are utilized.

Dividend Capture Strategy Timeline

To understand the best way to profit from the dividend capture strategy, we must first understand how dividend payments are typically processed.  Of primary importance is the Dividend Timeline, which includes four key dates: the Declaration date, the Ex-dividend date, the Record date, and the Payment date.  There are several financial websites that offer freely accessible calendars showing when these key dividend dates on popular stocks become due.

  • Declaration date: The company declares its intention to pay a dividend on this date (this occurs well in advance of the actual dividend payment).  Larger companies tend to announce their dividends in conjunction with quarterly earnings reports or through separate press releases.
  • Ex-dividend date (ex-date): The cut-off date for eligibility to receive the stock’s dividend payment. Anyone buying the stock after the ex-dividend date won’t be entitled to receive the upcoming dividend payment (and will be required to wait for the next payout period in order to receive the dividend).  On the ex-dividend date, the stock price usually drops in value by an amount that is roughly equal to the declared dividend value. Traders utilizing the dividend capture strategy must buy the stock before the ex-dividend date.
  • Record date: The company records shareholder ownership (confirming eligibility to receive a dividend payment) on this day.  This date occurs on the first business day that follows the ex-dividend date.  For dividend capture traders, no action is required on this day.
  • Payment date: On this, date dividend payments are distributed to shareholders (usually two weeks to one month following the ex-dividend date).

As a basic example of how the timeline works, let’s assume a stock’s ex-date is Wednesday, August 26th (two trading days prior to the record date).  The must-own day for the stock would be Tuesday, August 26th (one day prior to the ex-date and three days prior to the record date).

Investors owning the stock before the end of the trading session on August 26th will be eligible to receive the dividend payment.  In other words, a person must buy the stock by 3:59 pm on August 26th in order to be eligible for the dividend.  Traders could technically sell the stock as early as 9:31 am on August 27th and still receive the dividend payout on the Payment date.  This means the dividend will be paid automatically, regardless of whether or not the trader is still holding the stock when the dividend payment is received.

Benefits Of The Dividend Capture Strategy

For many investors, the appeal of dividend capture trading lies in the simplicity of the process.  In-depth fundamental analysis of each company isn’t a requirement and trading parameters generally require very little technical analysis in order to identify price levels for entries and exits.

Under the dividend capture strategy, investors are not required to hold the position until the final payment date in order to receive the guaranteed dividend payout.  Traders can purchase a stock prior to the ex-dividend date and then sell the position on (or after) the ex-dividend date in order to successfully complete the technique.  As long as these simple rules are followed, traders will receive a guaranteed dividend payout for their efforts.  If share prices fall after the ex-dividend date, traders still have the option to wait until market valuations return to their prior levels before closing the position.

Another advantage of the dividend capture approach is that traders can use thousands of different dividend-paying stocks when implementing the strategy.  Of course, some stocks offer larger dividends than other stocks, and some choices might be associated greater price volatility and overall risk.  However, traders that have experience with the dividend capture strategy have an incredibly wide pool of options available when making stock selections.

Every trading day of every year it’s possible to find a stock that’s scheduled for its ex-dividend date.  Obviously, the ability to capture guaranteed dividend payments every day is something that can lead to substantial profits.  This is why many capture strategists are willing to spend the time it takes to select the right dividend stocks when using this approach.

Dividend Capture Stock Selection

Generally, stock dividends are paid quarterly or annually.  In some cases, investors will receive dividend payouts once per month.  Fortunately, investors don’t need to wait for all this time to pass in order to capture these guaranteed payouts.  However, proper stock selection is critical in terms of its ability to prevent risk and maximize potential gains over time.

One of the most important secrets to success when implementing the dividend capture strategy is to diversify the stocks that are chosen to be used as part of a short-term trading portfolio.  There are many dividend stocks available in the market and diversification practices across industry sectors can help protect investors from macroeconomic shocks that might occur in certain areas of the market.

Individual stock selection and the primary direction of recent macroeconomic trends can have a tremendous influence on the profitability performances of any dividend capture strategy.  But when we are selecting stocks as part of this technique, traders must also focus on company-specific elements that make the stock suitable for inclusion:

  • Focus on stable large-cap stocks and mid-level dividend yields (3-4%)
  • Select companies with strong revenue growth and a history of beating analyst expectations when releasing corporate earnings reports
  • Diversify stock selections across industry sectors in order to avoid the effects of market volatility or unexpected macroeconomic events
  • Use technical chart analysis to identify stocks with healthy trend momentum
  • When favorable, roll over previous stock positions and re-invest profits into new dividend capture trades
  • Exercise patience in the event share prices drop after the ex-dividend date

Of course, macro trends in the broader market can have a tremendous impact on whether a short-term dividend capture strategy becomes profitable.  As a hypothetical example, many energy companies are known for the high dividend payments that are offered as a reward for shareholders.  However, there are many different types of macroeconomic influences which might positively or negatively affect share prices in popular stocks throughout the sector.

As a result, a dividend capture portfolio that focuses solely on the energy sector might perform very well in situations where energy commodities are rallying.  However, those same stock choices might underperform significantly in cases where valuations in energy markets are trading under pressure.  For these reasons, proper analysis is key when making stock selections.  Market experts often argue that a diversified selection of mid-cap and large-cap dividend payers with a stable history of earnings growth will provide the best results for traders implementing dividend capture strategies.  Traders might also consider buying exchange-traded funds (ETFs) and high-yielding stocks of foreign companies offered on the major European and U.S. trading exchanges as a way of finding additional opportunities to generate income.

How To Profit Using A Dividend Capture Strategy

As we can see, the variety of dividend stocks that is currently available to capture strategists is quite expansive.  Nearly every day, investors can find at least one publicly-traded company that is due for an ex-dividend date.  As a result, traders will always have new opportunities to benefit from the elevated dividend payouts that are made available in certain sections of the market.

One downside to the strategy is that it requires a substantial capital outlay for the initial investment.  However, the high stock yields associated with many Dividend Aristocrats help investors take advantage of elevated yield payments that are guaranteed (and compound frequently).  These compounded yield returns can then be re-invested into the next dividend capture trade and relative position sizes can continue to grow.

Since dividend traders are not required to hold positions for an extended period of time, capture strategists will often roll over holdings into new stock positions. This allows expert traders to capture dividends during every step of the process.  Moreover, this approach helps traders reduce risk exposure when compared to most other stock investment strategies.  Historical backtesting results suggest optimal trading returns can be achieved when capture strategies focus on large-cap companies that offer mid-level dividend yields of roughly 3-4%.  Ultimately, this stock selection parameters help to reduce risk exposure while maintaining attractive dividend payouts under the strategy. 

Enhanced Returns Using Alternative Strategy Techniques

As a variation on the most popular approach to dividend capture, advanced traders will also find ways to generate greater returns by selling options that profit when share prices fall on the ex-dividend date.  There are several different option types that can be used under these scenarios and traders should review our options tutorial to learn about how these strategies operate.

One of the most popular options strategies used in these instances is the Covered Call, which is an approach that can benefit from the initial declines typically seen in share prices following the ex-dividend date.  Interestingly, this is one of the few investment strategies available in the financial market that is capable of producing investment income from multiple sources (specifically, from the dividend payout and from the option sale).  Since share price activity tends to be negative (or sideways) during the trading sessions that follow the ex-dividend date, Covered Call options can provide a powerful profit enhancement to any dividend capture strategy.

Additionally, market research shows that announcements of special dividends can increase overall profitability when compared to dividend returns that can be captured through normally scheduled dividend payouts.  The reason is that special dividends offer one-off dividend payments that are structured differently (and tend to be much greater) than the regular dividends made available on a monthly or quarterly basis. This elevated dividend yield helps balance brokerage fees and share price fluctuations often seen in the market during the periods that follow a stock’s ex-dividend date.

Summary

  • Dividend capture strategies offer an income-focused approach to active stock market trading.
  • Capture strategists exhibit precise market timing, buy a dividend stock at appropriate levels, capture the stock’s dividend, and sell the stock with limited transaction costs.
  • Dividend capture strategies require traders to buy a stock on (or before) its ex-dividend date and hold the position long enough to receive the dividend.
  • The approach is popular with active money managers and day traders because of the high trade turnover required with this strategy.
  • In contrast to traditional dividend investments (which usually involve buying/holding the stock shares of dividend-paying companies to generate a steady stream of income), the dividend capture strategy is an active approach which requires frequent buying/selling and a willingness to hold stocks for a short period of time.
  • Initial trading risks are encountered when stock prices drop in value by an amount that is roughly equal to the declared dividend value.
  • In order to reach profits, traders must wait for share price gains to rise by an amount that’s greater than the dividend before selling the stock (assuming dividend eligibility is confirmed on the recording date).
  • Capture strategists can also buy a stock at a low price when a company announces its dividend (or shortly thereafter) and sell the stock the day prior to its ex-dividend date (capitalizing on the rise in prices).
  • Options contracts are able to enhance total income returns for traders willing to manage multiple position strategies at the same time.
  • Disadvantages of the strategy include the high capital outlay that is often required, the risk of initial declines in the stock, and the active trade management involved when opening/closing positions.
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