Dividend Arbitrage Definition

What Is Dividend Arbitrage?

Dividend arbitrage is an possible choices purchasing and promoting method that comes to shopping for put possible choices and an identical amount of underlying stock quicker than its ex-dividend date and then exercising the put after amassing the dividend. When used on a security with low volatility (causing lower possible choices premiums) and a first-rate dividend, dividend arbitrage can result in an investor realizing income while assuming very low to no threat.

Understanding Dividend Arbitrage

First, some basics on arbitrage and dividend payouts. In most cases speaking, arbitrage exploits the price permutations of identical or similar financial equipment on different markets for receive advantages. It exists on account of market inefficiencies and would not exist if the markets have been all totally surroundings pleasant.

A stock’s ex-dividend date (or ex-date for short), is a key date for understanding which shareholders can also be entitled to procure the dividend this is shortly to be paid out. It’s one in all 4 ranges occupied with dividend disbursal.

1. The main of the ones ranges is the declaration date. That’s the date on which the company broadcasts that it’ll be issuing a dividend one day.
2. The second stage is the file date, which is when the company examines its provide report of shareholders to come to a decision who will download dividends. Most efficient the ones which can be registered as shareholders inside the company’s books as of the file date can also be entitled to procure dividends.
3. The third stage is the ex-dividend date, usually set two business days prior to the file date.
4. The fourth and supreme stage is the payable date. Also known as the associated fee date, it marks when the dividend is in truth allotted to eligible shareholders.

In several words, you must be a stock’s shareholder of file not highest on the file date alternatively in truth quicker than it. Most efficient those shareholders who owned their shares at least two entire business days quicker than the file date can also be entitled to procure the dividend.

So, in a dividend arbitrage play, a broker buys the dividend-paying stock and put possible choices in an identical amount quicker than the ex-dividend date. The put possible choices are deep inside the money (that is, their strike price is above the prevailing proportion price). The broker collects the dividend on the ex-dividend date and then workout routines the put approach to advertise the stock at the put strike price.

Dividend arbitrage is supposed to create a risk-free receive advantages by the use of hedging the downside of a dividend-paying stock while having a look ahead to approaching dividends to be issued. If the stock drops in price by the time the dividend will receives a commission—and it usually does—the puts that have been purchased provide protection. Because of this truth, buying a stock for its dividend income alone will not provide the similar results as when combined with the purchasing of puts.  

Dividend Arbitrage Example

For example how dividend arbitrage works, believe that stock XYZABC is in this day and age purchasing and promoting at $50 in step with proportion and is paying a $2 dividend in one week’s time. A put chance with an expiry of three weeks from now and a strike price of $60 is selling for $11. A broker wishing to building a dividend arbitrage will have to acquire one contract for $1,100 and 100 shares for $5,000, for an entire value of $6,100. In one week’s time, the broker will achieve the $200 in dividends and the put approach to advertise the stock for $6,000. All of the earned from the dividend and stock sale is $6,200, for a good thing about $100 quicker than fees and taxes.