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The dividend collar strategy has the same aim as the dividend capture strategy, with several differences in the setup. While both are focused on the acquisition of the underlying company’s dividend, the dividend collar has the additional aim of protecting the position from any downside that might occur before the dividend is paid.
The dividend collar is therefore generally employed in a situation where the underlying security is already owned, whereas dividend capture is initiated just a day before the stock goes ex-dividend.
Who Should Consider It?
The dividend collar strategy makes perfect sense for stockholders who have just seen their shares surge dramatically and suspect there may be a near-term retreat – but who still want to pocket the upcoming dividend.
Before we look at a case study of the dividend collar in action, one more key point. The collar’s expiry must be set beyond the ex-dividend date of the shares. Otherwise, the shares might be called away and the dividend lost, negating entirely the purpose of the strategy.
Have a look now at a chart of DuPont (NYSE: DD):
The Scenario:
You own 500 shares of DuPont stock, but after a gain of over 40% in just two months, you worry that some enthusiastic profit-taking might be at hand. You wouldn’t mind cashing out, but you hate to miss the next dividend payout – a very sweet $1.05 per share payable to shareholders of record on Jan. 14, still two months away (red circle).
By the end of November, the tension is overwhelming. With the stock trading sideways and looking ripe for a tumble (green circle), you decide to write a dividend collar, allowing a little more upside for the shares while holding onto nearly all your current gains and securing the January dividend.
Costing the Collar
With the shares at $67, you buy five protective January 67 puts for $3.10 each and offset the cost with the sale of five January 68 calls for $3 apiece. Total debit on the trade is $50 ([$0.10 x 5] x 100) to insure all your shares. You’re also sure to check that the options expire after the ex-dividend date (blue circle).
And before long the market proves you right!
The stock pops higher for just a few days, then trails off strongly all the way to $53 at expiry. The calls expire worthless, but the puts kick in handsomely, rewarding you with $7,000 ([$67 – $53] x 5 x 100). That offsets the same decline in the share price of $14, for which you suffer a loss of $7,000. You close out both and walk away happy that you achieved all your goals.
In the final tally, you have:
- A loss of $50 for setting the trade; and
- A gain of $525 from the dividend, secured just days before the options expire and the shares are sold.
Had the stock continued to move higher through expiry, you would have been rewarded with a maximum gain of $500 ([$68 – $67] x 5 x 100), after which the short call would have kicked in to call away the shares. Along with the $525 received from the dividend, less the cost of the trade ($50), your net gain would have been $975.
Recap: Dividend collars allow full downside protection, limited upside gains and dividend capture, all at little to no cost.
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