Dividend Capture: Decrease Volatility and Increase Existing Holdings Cash Flow

David Hartzell submits:
Welcome back...Dividend Capture! Individuals concerned with ongoing high levels of volatility in the market should consider a strategy known as Dividend Capture, which was pioneered by Japanese insurance companies back in the early 1980’s. At that time, Japanese law required life insurers to pay policy holders from current income rather than capital gains. This is why the insurers were so eager for dividends. The Ministry gradually modified the law and insurers can now include some capital gains in their payments. Due to the commission structure at most American brokerage firms, Dividend Capture never really caught on in the U.S. In 1980, trading nine million shares of stock on the NYSE was too expensive for the relatively minor dividend payback. Flash forward to 2010. With the advent of "one price/all the shares you can trade" and the rise in dividend rates over the last decade, Dividend Capture is suddenly back in vogue. There are currently four ways that an individual can use a Dividend Capture strategy to decrease the volatility in their portfolio and increase their cash flow from their existing holdings:

1. Buy a stock that pays a 5% (or greater dividend) two weeks before the X date, and sell it two days prior to the X date. This strategy works well because of the increase in volume and the rise in price immediately prior to the dividend (which is known in academic circles as abnormal volume around the ex-dividend date) and has been the subject of many studies.
2. Buy the stock the day before it goes X, capture the dividend, and sell it the next day. This is the most common Dividend Capture strategy, and the subject of the most academic research (Campbell and Beranck 1955, Durand and May 1960, etc). While the market is rising, this is the simplest, most efficient and least volatile way to capture dividends.
3. Buy the stock after the X date, and hold it to the payment date. Excess returns are relatively high on the payment date and on several subsequent trading days immediately after it.
4. Short the stock the days after it goes X dividend, and cover the short within seven days. Take advantage of the post X drop to pick up a quick gain after the dividend has been paid.

During the summer of 2004 Mohammed Sorathia, then a graduate student at the University of Buffalo, and I wrote "Dividend Capture: From Theory to Practical Application." It contains a detailed, academic explanation of each of these four strategies. I sincerely hope that my condensed version helps you trade profitably in this time-tested strategy. Please note: I have used Dividend Capture as a very profitable trading strategy for many years, but it's strength lies in actively using Dividend Capture ONLY during prolonged bull markets. No matter how nimble you think you are, or how sophisticated your trading technology is, Dividend Capture will absolutely get you killed during a bear market.Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.Complete Story »