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Best way to guarantee future sale price

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22 August 2013
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Hi All,

Im wondering about the best way to lock in a future sale price for a stock. eg, I would like to sell a stock in 1 month for the price it is today in order for me to collect an upcoming dividend. Would it be best to pay for an option that guarantees me the right to sell them at specified price on specified date?
 

Yeah, buying an at the money put option would achieve that.

That way you guarantee a minimum sale price and collect your dividend, and the option seller earns a premium for insuring your position.
 
Don't forget option pricing accounts for dividends. So you will pay up for the put. The question then becomes - is the exercise worth it?
 
Thanks, ill look into a put option and the expenses for taking them out. 2 x dividends per year - expenses, will hopefully outstrip savings account returns.
 
Thanks, ill look into a put option and the expenses for taking them out. 2 x dividends per year - expenses, will hopefully outstrip savings account returns.

Look into it, but I think you will spend more than the dividend if you attempt to hold the put option position for 12 months, holding the put option position will be a net cost, so unless this is offset by future rises in your share price, your position will lose money if the share price just sits where it is now and doesn't go up.

If you feel that the share price will rise enough over time to offset the put option cost, you may be better just accepting the flucuations unhedged along the way, and keep the full dividend,
 

I'd like to be entering and exiting the position within say 1 month around dividend, and then do the same before next dividend instead of the 12 month hold (for the reasons you mentioned). While I havent researched all the costs of multiple contracts, premiums, exercising options etc, I thought the possibility of dividend shopping throughout the year with a hedge against price dips might provide a better return and still be safe.
 

By all means look into it, there may be some situations where you can arbitrage dividends in this way, I would think it would result in a small loss though, because the cost of the put combined with the buying and selling of the stock will likely be higher than the dividends, so you would still be relying on the stock price to increase to provide your return.

Is there some reason you are averse to holding shares? A diverse list of say 10 good companies would probably provide you a better return over time than attempting to dance in and out of low profit dividend arbitrage situations, that way you get to keep all of your dividends without the put premiums and trading costs, and a diverse list and sensible holding period will provide protection from loss, your list will likely have more winners than losers, so the winners and the full dividends offset any price decline in a loser you hold.
 

not sure if you're looking at aust or US stocks (i'm assuming aust as the divs are higher plus aust has franking), but even with the higher yields of aust stocks, unless the implied vol is really low the premium will probably eat up just about all the div. especially if you're subject to the 45 day rule and must therefore buy put options out to 2 months rather than just 1.

if you really want an "insured divvy strip", you could consider collars. if you're divvy stripping you're probably prepared to sell the stock in 1 or 2 months anyway, depending on whether you have to abide by the 45 day rule, so there's less downside in selling covered calls to finance the purchase of the puts. you do have to take measures to avoid the risk of the div being called out from under you though, such as going for the illiquid european style calls, and that can be a bit of a downside to the strategy.
 
If I read you right, you are trying to profit from the dividend run-up and harvest effect whilst protecting your downside via the use of options. Alternatively, you are seeking to somehow profit from the fact that yields on stocks are higher than cash at bank without taking capital risk.

As others have said, pursue by all means. However, these are some issues you may wish to consider:

Dividends are not interest: If you are acting on a belief that dividends are somehow like interest payments on a fixed cash amount, this is not an accurate understanding. Dividends to a stock is not like interest to a bank. It goes beyond the fact that capital movements can occur in share prices (we can usually ignore that deposits could be subject to haircut in a credit event). For a start, you will notice that share prices usually fall as a stock goes ex-div. A bank account does not fall when interest is paid.

Tax: To Gain access to franking, you need to be 'at risk' for 45 days around the dividend ex date.

Costs: You will cross spreads and pay brokerage to put on any of these legs. Buy/sell on brokerage alone will diminish any perceived advantage quite significantly. If you factor in the buy/sell spread you will almost certainly take on the options leg(s), you have a higher hurdle.

Options pricing: The market is not naïve to the concept that you are trying to extract. If it were frictionless (ie. no spreads etc.) the options market will price the combined strategy of buying a stock and hedging out all capital movements via options (by buying a put and selling a call for the same maturity and same exercise price) and basically ensure that this is expected to match the return which wholesale funders get (BBSW, usually higher than prevailing cash for deposits). Beware of call risk though per SM's post. In the market for single stocks, the options prices also reflect the value of franking credits to some degree. For highly franked and high dividend stocks (the type that is front and centre for this idea), the options market almost factors all of it in. Others are doing what you are thinking about to some degree. In aggregate, it takes away at least some of the opportunity you perceive.

Capital risk: By only putting on puts or having various collar strategies, you are taking on capital risk. Your outcome will be impacted by market movements. If you buy a stock and put protect it, you have essentially purchased a call option at the same strike. Perhaps that viewpoint might assist in seeing the inherent idea. Stock plus put equals a call. You will pay for that call option. Overall, that call option will generally be priced such that the expected return from it will not exceed BBSW by much before expenses, especially for the kind of set-up that you seem to be thinking about (and may include allowance for franking per above).

Other ideas:

+ Some suggestions have been made about buy-hold a small portfolio of stocks. Over the near term, these will be affected by large market-wide movements. If 2007/8 happened again, it is unlikely this stock portfolio will produce a positive outcome. Over the long term, if you believe that equities will outperform cash, a buy-hold could do better. In my opinion, this is the case for a broad market. This falls short of a guarantee. If you concentrate your holdings into a handful of stocks, you will appreciate that your destiny rides with this handful and your prowess in their selection.

+ Given the above, it might be an idea to roll out put protection on the ASX 200 as cover for the portfolio if near term variations in capital value concern you. The ASX 200 is not your stock portfolio and hence any difference between the performance of the stock portfolio and the ASX 200 is essentially uninsured. The advantage here is that the price of put protection will be lower given you are insuring a basket rather than individual stocks...which allows for some benefit due to diversification in the option price. ASX 200 options are also more liquid (trade with tighter ranges) than individual stocks. Other option strategies over the top of this might be possible. IMO, this is the best way forward if cash is your close alternative. I kinda, sorta, do this.

+ Instead of exposing yourself to equity risk in trying to obtain above-cash returns, another idea may be to purchase the credit of these companies. These are usually a whole lot more stable, but that will greatly depend on exactly what you are thinking of buying. This is closer to a cash-plus concept. I kinda, sorta, do this too.

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All the best with your assessment. More return without more risk is the right idea. Getting that idea into practice is the challenge. Often-times, it will require bearing more risk to get that higher return. Guarantees exist, but usually at prices that take out all of the benefit. Usually.
 
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