What happens if you call goes in the money and you are exercised away before the div? What’s your return then?
Dividend strat
- Thread starter misterkel
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What happens if you call goes in the money and you are exercised away before the div? What’s your return then?
GREAT question. You're right - that does introduce risk.
If there's a premium - that shouldn't happen. the holder should sell the call, and buy the stock directly. So - setting the expiry date a few weeks past ex-div would make that pretty unlikely, unless there's a huge runup to wipe out the premium. If so, I can adjust the short synthetic. Might damage the P/L, but still wouldn't lose money.
But it appears easy to manage - if the conditions look likely - adjust. If exercised enough before ex-div - re-enter the position by selling a call, buying stock.
Anyway, I entered the trade with one synthetic and 100 shares as an experiment.
12.92 for underlying. 1.20 for synthetic. Profit would be = .46 on
What underlying do you think you will earn 46 cents on? That sounds too high for a dividend arb (which is what you are proposing).
IBM.
TWS calls the trade a conversion - which, yeah - is an option arbitrage.
And I am looking for where my math is wrong - if it is.
Maybe it's because the ex-div date is still 2 weeks out? The options will steadily adjust up to ex-div date? I don't know how the market does that.
Any input appreciated. This conversion sells for 9.37 at the ask. Closes in 26 months at $10 - so risk-free. Buyer is long GE, so gets quarterly dividends of .12.
Total profit, risk-free, should be .63 for the trade + .12 X 9 = 1.08 or 1.71.
2 years against 9.37 = 5% risk free.
Obviously, you can get the trade for less.
At 9.2 (above the mid), the trade yields 9.4%.
Is it risk-free?
Didn't GE just cancel all their dividends
Reduced 92% to $.01/share, effectively what you said.
My advice to the OP is that you seem to be overly reliant on the data your platform spits out when it comes to dividends and are making the assumption that dividends stay constant. As we've seen the first is dangerous, I can also tell you that the second can be a rash assumption. Dividends change all the time, GE case in point. This time in 2017 you might have said something like "GE's only cut dividends once since the great depression, we can depend on them to either keep it the same or increase it". Then they make a big cut in Nov 2017 and effectively eliminate it this week, all in the space of a year.
You can apply this strategy to multiple dividend paying stocks, similarly to how you would diversify a dividend portfolio otherwise.
I think you'd find that the "arb" opportunity you see is actually the consensus for the probability that the dividend is downgraded in the time necessary to profit from the arb. So diversifying would just make it more likely you achieved exactly zero expected value profit.