I am looking at this example to capture dividends using long stock and covered call.

What is the risk in this strategy? There is no delta risk, since the position is delta neutral. So it seems like I am just going to collect the dividend without any risk., Looks like a free lunch.

Please point out the catch :)

  • 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. It is there in the article. – DumbCoder Mar 16 '15 at 15:25
  • will have drop by the dividend amount Not always true(in theory yes), by the time the market opens. Might be less might be more also. – DumbCoder Mar 16 '15 at 15:27
  • I meant, the risk except for early assignment. – Victor123 Mar 16 '15 at 15:36

Typically the catch is liquidity, and the margins are pretty small, so you can't just leverage up and make a percentage off that. Typically you'll be trapped in the options position.

  • Thanks. Many underlyings like SPY,USO have good liquidity 2 - 3 strikes ITM. I understand your point about leverage though. Thank you. At this point, I am happy just making 100-200 dollars extra/month on a 10,000 dollar account. Leverage is a long term goal for me, not presently thinking of that. – Victor123 Mar 16 '15 at 15:37
  • 1
    @Victor123 right right, well they are very liquid, and get more liquid every year. But inevitably, you may wind up looking at optionable securities with large dividends, those are the ones where there is no play. – CQM Mar 16 '15 at 15:49
  • Got you, the bank stocks. Thanks! So much for free money. – Victor123 Mar 16 '15 at 15:57

Ignoring that XYZ at $50 is paying what is assumed to be a quarterly dividend of $1.50 (12% a year?), there are two risks.

The first is that your $40 covered call is most likely going to be assigned before the dividend.

The second, though slim, is that the stock gets clobbered and drops below the strike price. It's only hedged above $40.

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