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Is it possible to use options to collect dividends on stocks while insulating yourself from the volatility? If so, how?

e.g., If I bought 100 shares of a REIT but didn't want to expose myself to fluctuations in the value brought about through interest rate changes or QE3 changes, could I buy an option to insure myself against sharp changes in value?

Something like this:

  • buy 100 shares at $50 (worth $5000)
  • buy a put option to sell 100 shares at $45 (worth e.g. $100)

Then if the stock drops to $25, and pays a 10% dividend I should have:

  • 100 shares at $25 (worth $2500)
  • 1 options contract ($2000 "in the money")
  • $250 worth of dividends

For a net loss of $350

Similarly, if the stock stays the same value, I should have a net gain of $400 (dividends less the cost of the option expiring)

Or does the volatility cause the premium on the price of the options to be too high to make this worthwhile?

Thanks,

  • If you are willing to curb the upside potential a bit, you can further reduce the cost of the protective put by selling an out of money covered call at 55$ strike. This is called a collar. The proceeds of the call finance the put. Problem is your upside gain is limited to 55$. – Victor123 Feb 9 '15 at 1:31
3

The strategy is right. As pointed out by you, will the " volatility cause the premium on the price of the options to be too high to make this worthwhile" ... this is subjective and depends on how the markets feels about the volatility and the trend ... ie if the market believes that the stock will go up, the option at 45 would cost quite a bit less. However if the market believes the stock would go down, the option at 45 would be quite high [and may not even be available].

There is no generic right or wrong, the strategy is right [with out without putting dividend into equation] it depends what options are available at what prices.

  • 2
    The US options I'm familiar with have no clauses such as the last sentence here. Is this a characteristic of options on a particular exchange? – JoeTaxpayer Aug 2 '13 at 4:15
  • India had this. Editing the answer to remove the last sentence else it may confuse everyone. – Dheer Aug 2 '13 at 4:24
  • OP didn't indicate country, so the comment may still apply. – JoeTaxpayer Aug 2 '13 at 13:08

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