Dividend Capture using Covered Calls

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Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date.

Many people have tried to buy the the shares just before the ex-dividend date simply to collect the dividend payout only to find that the stock price drop by at least the amount of the dividend after the ex-dividend date, effectively nullifying the earnings from the dividend itself.

There is, however, a way to go about collecting the dividends using options. On the day before ex-dividend date, you can do a covered write by buying the dividend paying stock while simultaneously writing an equivalent number of deep in-the-money call options on it. The call strike price plus the premiums received should be equal or greater than the current stock price.

On ex-dividend date, assuming no assignment takes place, you will have qualified for the dividend. While the underlying stock price will have drop by the dividend amount, the written call options will also register the same drop since deep-in-the-money options have a delta of nearly 1. You can then sell the underlying stock, buy back the short calls at no loss and wait to collect the dividends.

The risk in using this strategy is that of an early assignment taking place before the ex-dividend date. If assigned, you will not be able to qualify for the dividends. Hence, you should ensure that the premiums received when selling the call options take into account all transaction costs that will be involved in case such an assignment do occur.


In November, XYZ company has declared that it is paying cash dividends of $1.50 on 1st December. One day before the ex-dividend date, XYZ stock is trading at $50 while a DEC 40 call option is priced at $10.20. An options trader decides to play for dividends by purchasing 100 shares of XYZ stock for $5000 and simultaneously writing a DEC 40 covered call for $1020.

On ex-dividend date, the stock price of XYZ drops by $1.50 to $48.50. Similarly, the price of the written DEC 40 call option also dropped by the same amount to $8.70.

As he had already qualified for the dividend payout, the options trader decides to exit the position by selling the long stock and buying back the call options. Selling the stock for $4850 results in a $150 loss on the long stock position while buying back the call for $870 resulted in a gain of $150 on the short option position.

As you can see, the profit and loss of both position cancels out each other. All the profit attainable from this strategy comes from the dividend payout – which is $150.

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27, Dividend Capture With Covered Calls

“The only thing better than an asset that produces an income stream is an asset that produces TWO income streams.”

– typical covered call investor

This article shows how to generate two income streams (dividends and option premium) from a single asset (shares of stock). We’ll also show a brief video on how to use software to quickly find good dividend stocks to write covered calls on.


Most large companies pay dividends. In fact, 84% of the S&P 500 companies (420 of the 500 companies) pay dividends. There are some notable (large) companies among the 80 that do not pay dividends: Amazon, Facebook, and Google, for example. These companies are reinvesting their profits for new growth initiatives rather than return it to shareholders.

Current Dividend Yield

As of today, Feb 27, the S&P 500 average yield is 1.94%. Relatively low but not surprising given an 8 year bull market that has increased stock prices, as well as the current low interest rate environment (which means that companies don’t need to pay high dividends to attract investors).

Historically, the S&P 500 average dividend yield has been higher, typically above 3% for the 100 years prior to Black Monday in 1987:

Of course, that 1.94% is an average. Many S&P 500 companies pay quite a bit more than that.

Top 10 Dividend Yields In S&P 500

Some stocks pay nearly double the average dividend yield. For example, here are ten S&P 500 stocks that currently have a dividend yield of 3.6% or more:

Company Symbol Price Est Div Div Yield
American Electric Power AEP 64.76 2.44 3.77%
Consolidated Edison ED 74.52 2.78 3.73%
Gap GPS 25.03 0.93 3.72%
ExxonMobil XOM 81.89 3.04 3.71%
Exelon EXC 35.92 1.32 3.67%
SCANA SCG 66.96 2.45 3.66%
Weyerhaeuser WY 33.98 1.24 3.65%
WEC Energy Group WEC 58.07 2.11 3.63%
International Paper IP 52.76 1.90 3.60%
Public Storage PSA 227.73 8.20 3.60%

3.6% Per Year Income Stream

If all you wanted was a 3.6% per year income stream, you could just buy a portfolio of stocks that had an average dividend yield of 3.6% per year or more (such as those above).

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But if you want even more income, then you can layer on a covered call strategy on top of dividend paying stocks. Before we talk about that, let’s review when you need to own a stock in order to receive its dividend.

Ex-Dividend Date

A stock’s Ex-Dividend Date (also known as ex-div date or ex date) is the first day the stock trades without the dividend. In order to receive the dividend you must own the stock by the close of market on the day before the ex-dividend date.

For example, if a stock has an ex-div date of March 5, you must own the stock by close of market on March 4 in order to receive the dividend.

If you sell your stock before the ex-div date then you will NOT receive the dividend.

Likewise, if you buy the stock on the ex-div date you will NOT receive the dividend.

If you want to hold the stock for as little time as possible and still get the dividend, you can buy the stock just before the market closes the day before the ex-div date and then sell the stock just after the market opens on the ex-dividend date. You may make or lose a little on the stock, but you will get the dividend for sure.

Other Dividend Dates (Which You Can Ignore)

Although the ex-dividend date is the only date that matters to most investors, there are 3 other dates that relate to dividends: declaration date, record date, and payable date. Although important, all you need to focus on is the ex-div date. As long as you own the stock by the end of day on the day before the ex date then you will get paid the dividend (although you won’t receive the money until the payable date).

The is the date the company declares the dividend (approves and announces it). This is just an informational date and can vary from days to weeks prior to the ex-dividend date. It only matters because a dividend isn’t official until it is declared by the company’s Board of Directors.

The is the date by which you need to be a shareholder of record in order to receive the dividend. It is normally 2 days after the ex-dividend date because it takes a couple of days for share transactions to settle. So you have to buy the stock before the ex date in order to have the transaction settle (ie. be a shareholder of record) on the record date. Holidays come into play sometimes, too. But you can ignore all this and just focus on the ex date to know if you’re going to get the dividend or not.

The is the day you actually receive the cash from the dividend. It can be days to weeks after the record date. You can sell your stock before the payable date and still receive the dividend payment (as long as you own the stock the day before the ex-dividend date thru the morning of the ex date you will receive the dividend).

Why Ex-Dividend Dates Matter To Covered Call Writers

Sometimes covered call writers will be subject to early exercise (meaning, the buyer of the option will exercise his right to purchase your stock before the option expiration date) just so they can capture the dividend. If this is going to happen then it usually happens to ITM (in-the-money) options the day before the ex-dividend date. But normally it will only happen if the amount of time premium remaining in the option is zero or a few pennies.

Example Of Early Exercise

You own 100 shares of ABC stock, and it’s currently trading at $51/share. You had previously sold a call option with a 40 strike, and that option is currently trading for $11 (at parity, no time premium remaining because it’s 11 points ITM). ABC goes ex-dividend tomorrow and will pay a $0.50 dividend.

Will the option holder do an early exercise on you today?

Yes, because tomorrow morning (the ex-div date) the stock will open lower by the amount of dividend paid ($0.50), and deep ITM options will be lower by that same amount. In order to avoid a loss equal to the amount of the dividend, most deep ITM options with no (or very little) time premium remaining will be exercised.

If the option had more than a few pennies of time premium remaining then the option would probably not be exercised. Depending on the bid-ask spread for the option holder, as well as his commission rates, he would probably be better off just selling his option rather than exercising it.

And this is probably obvious but if a stock does not pay a dividend (and therefore has no ex-dividend date) then the odds of early exercise are practically zero (because the person doing the early exercise is giving up any remaining time premium — he’d be better off just selling his option rather than exercising it).

Writing Covered Calls On Stocks About To Go Ex-Dividend

Shorting a call option on a stock you own just before its ex-dividend date is a common income-oriented strategy. Assuming the covered call is not exercised, you will receive both the dividend income and the call option income. Let’s look at an example:

Example Dividend Capture With Covered Call

Example from Feb 22. The following day, Feb 23, is the ex-dividend date for CVI. The stock trades at 23.12 per share and the dividend is 50 cents. So, if we had bought 100 shares of CVI on Feb 22 and then sold a March 17 expiration, 25-strike call option (trading at 35 cents), we would have received both the 35 cents from the option and the 50 cents from the dividend. That’s 85 cents per share of income in about a month on a $23 stock. Here’s the math:

  1. Buy 100 shares of stock: $23.12 per share = $2312
  2. Sell 1 call option: March 17 expiration, 25-strike call option for 35 cents = $35 income
  3. Tomorrow’s dividend of 50 cents = $50 income

Now, if we hold the stock until March 17 and if the stock is unchanged between now and then, we could sell the stock for $23.12 and our return would be:

  1. Total income = $85
  2. Total investment = $2312
  3. Return = 85 / 2312 = 3.67% in 24 days, which is 56% annualized

In The Money vs Out Of The Money Covered Calls

In the previous example the strike price ($25) was above the stock price ($23.12), which is the very definition of an ‘out-of-the-money’ (OTM) covered call. While there is potential for some upside capital gain (the difference between the strike price and the stock price), there is also risk that the underlying stock will go down before expiration, thus reducing or eliminating the income generated.

A way to reduce that risk is to use ITM (in-the-money) strike prices instead of OTM strike prices. Instead of a 25-strike we could have used a 20-strike, for example. This removes any chance of a capital gain but it provides much more downside protection. Because, if the stock drops from 23.12 to 20 you will still make a profit from the dividend and the option premium. If the stock drops below 20 then you may have a loss, depending on how far the stock drops. Nothing is risk-free.

How To Quickly Find Stocks About To Go Ex-Dividend

You can use software such as Born To Sell’s covered call screener to identify all stocks that have a dividend coming up. Just use the Search Dividends feature and set the Expiration Date slider to the option expiration date you are most interested in. The software will find all stocks that have an ex-dividend date before your chosen option expiration date, and then show you matching covered calls. Here is a 3-minute video of this dividend capture feature and process:

140 Opportunities Per Month

If we only count the 420 S&P 500 dividend-paying stocks, and if we assume they pay dividends 4x per year (quarterly), that’s 1680 dividend capture opportunities per year, or about 140 per month. The challenge is being able to find them quickly, and at the same time remove high-risk situations such as an earnings release before expiration, or super high P/E ratio stocks. The Born To Sell software does all of this for you.

Dividend Capture using Covered Calls

High-volatility trading environments can be great for some traders and horrible for others. It just depends on what kind of trades they take and what strategies they partake in. One strategy that works in a number of different environments? Capturing dividends via covered calls.

So how exactly do we go about capturing dividends?

Capturing dividends is a relatively conservative options strategy. It doesn’t rely on home runs, but rather, a series of continuous singles and walks to get on base. Is it the sexiest strategy out there? Not really. But when it comes to profits, there’s no reason to discriminate.

Understanding Dividends

Our goal here is pretty simple: Capture the dividend. To do it, we first need to select a dividend-paying stock. It tends to work best with names that pay out a decent yield. 2.5% to 3.5% and above work well, but below that it can become more frustrating for investors.

Next, we’ll need to see when the company plans on paying that dividend and when the stock will go ex-dividend. A stock goes ex-dividend on the first day of trading where new investors will miss the dividend payment. Remember that it takes three days for a trade to settle. So if the record date is April 4th, we need to own the stock at the close of business on April 1st. In this case, the ex-dividend date would be April 2nd. Here’s a visual:

The company generally announces when the record dates and payment dates are, the latter being the date that investors who own stock on the record date will collect their payout. If it’s a quarterly dividend, the stock will have four record dates, ex-dividend dates and payout dates per year.

The ex-dividend date has a big impact when it comes to capturing dividends. But before we get into the why, let’s talk about the trade’s structure. What we’re doing here is selling an in-the-money covered call. We want to do so before the company’s ex-dividend date. Inevitably, some call-holders in the name will exercise their long call options in order to collect the dividend.

Say ABC is trading for $63, pays out a 2.8% quarterly dividend yield and goes ex-dividend on March 5th. Currently, it’s February 20th.

We may buy 100 shares of ABC and then consider selling the March $60 in-the-money call option as part of our dividend capture strategy. With about a month until expiration, let’s say the $60 call is going for $4.00. We sell that call, knowing that unless ABC falls more than

5% to below $60, we could get exercised.

There are a number of scenarios that can play out now:

  1. 1. Shares stay above $60 but we don’t exercised before the ex-dividend date, allowing us to collect the 42-cent-per-share dividend ($42) plus keep the net credit we collected on the $60 covered call ($1.00). In all, this will allow us to pocket our maximum profit of $142, a 2.2% return, excluding commissions.
  2. Shares stay above $60 but we are exercised before the ex-dividend date. This means we don’t collect the dividend, but we do keep the $1.00 net credit.
  3. Shares tumble to $61, we’re exercised and we still keep our $1.00 net credit.
  4. Shares tumble below $60 before the ex-dividend date and close at $59 on expiration. Ultimately our loss on the stock omits our gain on the net credit, but we still collect the $42 dividend.

De-Risking While Capturing Dividends

Investors need to consider the potential decline in their initial equity position. In our case above, we are buying 100 shares of ABC at $63. We are “covered” down to $60, below which we start seeing our net credit erode. Technically speaking, we are covered a bit more should we collect the dividend, but since it is not known whether we will collect the dividend, we cannot guarantee that income.

So how can we derisk? The first option is simple: lower the strike price of the covered call. If we sell a lower strike price on ABC, it lowers the odds that ABC will decline below our short call. However, that also lowers the time value in the short call.

Here’s an example:

Stock at $63, sell the $60 call for $4.00; Intrinsic Value = $3.00, Time Value = $1.00

Stock at $63, sell the $55 call for $8.50; Intrinsic Value = $8.00, Time Value = $0.50

There’s nothing wrong with this strategy per se, but just know that it’s a more conservative strategy for capturing dividends.

One other way to lower investors’ risk? By implementing a protective put. Of course, when we buy 100 shares of stock, sell a covered call and buy a put, this is known as a collar. This protective strategy cuts into our potential upside, but also limits our downside. The move will generally cut into most of the net credit we receive in the trade, but eliminates our risks too. If we’re lucky, we’ll still be able to collect our dividend if we’re not exercised on the short calls.

Using Options Party

The Option Party platform can easily help us with capturing dividends. For this strategy, I like to make an entirely new screener. Adjust the level of probabilities you want for the trade, but remember that most of the trades will have a 0.1% chance of total loss, because in order to absorb the maximum loss, the stock would need to go to zero.

Under the “Stock – Financials” tab we can select stocks with a minimum yield and under “Options Expiration” we can make sure the stock or ETF goes ex-dividend before expiration. Under the same category, we can also adjust the maximum days until expiration.

Traders can tailor the rest of the screener to their specific preferences. I personally like to use the Opportunity Alerts feature, so I don’t have to constantly refresh the results and perform manual searches. The system will simply let me know when new trades pop up.

Remember, just because the strategy only returns 1% to 3%, generally speaking, doesn’t mean it should be ignored. A 2% return per month comes out to a 24% gain on the year, which is usually enough to beat the averages.

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