Selling vertical call spread before ex-dividend date

Pekelo

Pekelo

It looks like it is kind of easy money unless I am missing something. A few days before the ex-dividend day selling a vertical call spread for credit with 2 weeks or less to expire. Since the stock is going to drop the dividend, it is going to a have a short time and thus smaller chance to recover to reach the sold strike. Or so I think.

Case in point: BP.

Stock at 35.7
Selling the 36 17 Feb17 for 46 cents
Buying the 36.5 17 Feb17 for 28 cents

Credit is 18 cents - com.

Let's assume the ex-dividend day is tomorrow, the stock should drop 50-60 cents tomorrow (div. is 60 cents), so it has to recover a dollar to rich 36 in 2 weeks where I start to get hurt.

Fairly easy strategy with low beta stocks. Or am I missing something? Is there a better way to play this without having naked calls?
 
On thing to keep in mind is that low beta isn't the same thing as low volatility. Beta is essentially correlation to the broader market, a .5 beta stock would be expected to move .5% for every 1% move in the S&P 500, for example. Note that BP actually has a beta just over 1, so it's not really even low beta. However that only reflects systemic volatility, each stock has it's own idiosyncratic volatility that can be huge. A stock could randomly go up and down an average of 50% a day, but if it was completely uncorrelated with the S&P 500 it would have a beta of 0. GLD is an example of this, it's an ETF that tracks the price of gold and it has a beta of .07, but the price of gold is hardly a stable price.
BP would have to go up by 3.1% (36.18-35.10)/35.10 in two weeks for you to start to lose money. I did a quick Excel run and it looks like BP has gone up more than 3.1% during a 10 trading day period a total of 36 times between Feb 2nd of 2016 and today, or about 15% of the 10 day periods. That seems like a fairly likely event, so I'd say the spread is fairly priced and definitely not underpriced.
 
Pekelo:
You likely have much more experience with this than I, so take with grain of salt.
I did some work with trading around dividends (backtesting and live). I found no systematic edge by observing history! -- seemed to have similar results to dice rolling! Observing 10 out of 10 successes for a particular underlying did not seem to have influence on next event! -- I looked at drops in price following exdividend that exceeded the expected amount (as well as the opposing for 4,3,2,1 day prior to eod of and eod following Ex date). I bought PUTs (very short term, so theta decay not an issue), and where the options had insufficient liquidity, shorted the underlying. <-- Results indicated my efforts were futile
 
Ai.... mate, dividends are taken into account already... that call spread is basically priced on a stock of 35.10 not 35.70. Plus a little extra premium for the chance that it will be priced higher because it could be ITM/early exercised before dividend (extra gamma).

That strategy might work, but it's no different than selling it the day after dividend.
 
Pekelo said:
It looks like it is kind of easy money unless I am missing something. A few days before the ex-dividend day selling a vertical call spread for credit with 2 weeks or less to expire. Since the stock is going to drop the dividend, it is going to a have a short time and thus smaller chance to recover to reach the sold strike. Or so I think.

Case in point: BP.

Stock at 35.7
Selling the 36 17 Feb17 for 46 cents
Buying the 36.5 17 Feb17 for 28 cents

Credit is 18 cents - com.

Let's assume the ex-dividend day is tomorrow, the stock should drop 50-60 cents tomorrow (div. is 60 cents), so it has to recover a dollar to rich 36 in 2 weeks where I start to get hurt.

Fairly easy strategy with low beta stocks. Or am I missing something? Is there a better way to play this without having naked calls?
More...


based on my observation of a lot of dividend stocks for a strategy i use in my IRA, its not uncommon for them to rise that amount in two weeks after dividend date,

another indirectly related comments, on dividend stocks the puts are usually if not always more expensive than the calls, reason being if the put was on anuual basis cheaper than the dividend rate then it would provide the free lunch which arbitrageurs will insure wont be the case,

for example if dividend is 5% annually then the put price of an option at the money for one year will NOT be less than 5% of that strike price, cuz if it was then you can buy the stock and collect 5% dividend and buy the put for 4% lets say and have a riskless trade of 1% gain,, PUT CALL parity makes the price of the call also affected

here is a classic example with Verizon,,, Strike 47, notice the put is more expensive than the call even though the call has 1.28 intrinsic value and the put has ZERO IV

bottom left

upload_2017-2-2_22-14-39.png
 
@systematictrader,

The reason is that all put options are priced on the ex-dividend price of the underlying. And depending on which strike, some calls are priced on the cum-dividend and some/most are priced on the ex-dividend underlying.
Put call parity will actually not hold anymore when dividends are involved. Because when an ITM call is valued on the cum-dividend value of the underlying and is to be exercised early... the same strike put is valued on the ex-dividend price... So both have basically different underlyings, as well as different maturities (because of early exercise).

While technically you are correct re dividend/put value etc... that's more of an effect instead of a cause.
 
Below is an example of a trade I was trying before. Observing prior price action of Devon Energy around Ex Dividend time (looking 4 days prior, to one day following), and looking for a downward move greater than the ExDividend value, implies that the best performance is to sell 4 days prior to ExDividend date, then cover/exit by Close the day following ExDividend date. Only once in the past 8 Ex dividends would this lose money. --- Issue is the history is not a good predictor of the next event. This shows a ThinkScript I wrote to make the evaluations then display the most profitable one. The purple shaded areas are the times positions would be in play.
upload_2017-2-2_20-40-18.png

As I mentioned earlier, success rates turned out to be less than desirable.
BTW: the notation [4,1] means begin 4 days prior to ex div date, and exit 1 day following ex div date. -- Grades for all cases are shown for wins in white.
 
JackRab said:
@systematictrader,

The reason is that all put options are priced on the ex-dividend price of the underlying. And depending on which strike, some calls are priced on the cum-dividend and some/most are priced on the ex-dividend underlying.
Put call parity will actually not hold anymore when dividends are involved. Because when an ITM call is valued on the cum-dividend value of the underlying and is to be exercised early... the same strike put is valued on the ex-dividend price... So both have basically different underlyings, as well as different maturities (because of early exercise).

While technically you are correct re dividend/put value etc... that's more of an effect instead of a cause.
More...


Very interesting, more knowledge, i like it, i became immersed in this about 2 years ago when i started doing this simple strategy for large cap div stocks where i try to buy them when their yield is 6% (annual dividend divided by .06) any ways, some stocks large cap stocks never make it that low to my buying point, so i decided to use the puts to replicate the 6% iam after, and i coined it the term synthetic dividend, the results is i short the puts at the strike price of where i would buy the stock at, question is how much do u sell the puts for?? and the answer strike price times days remaining times (.06/365)

this ensures minimum yearly earning is 6% on that stock via puts even though the stock never dropped that low to begin with

thanks again for the added info, truly appreciated
 
systematictrader said:
this ensures minimum yearly earning is 6% on that stock via puts even though the stock never dropped that low to begin with
More...

It's actually the maximum earning... since you have no upside potential and only downside risk.

Be careful with that strategy...
 
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