Review of Dividend Dates & Their Impact on Our Covered Call Trades – February 21, 2023
The main reason for early exercise of our covered call writing options relates to corporate dividends. The key date to be aware of is the ex-dividend date. This article will clarify and define the dates related to corporate dividends and also discuss an anomaly related to special dividends.
Early exercise of our covered call options
Before definitions are presented, here is the main takeaway of this article:
Shareholders are owed the dividend if they are determined to be shareholders on the record date. An investor would need to own shares on the date prior to the ex-date in order to be (or become) a shareholder of record on the record date (usually the following day). Since the exercise of a call option results in the purchase of shares on the exercise date, it is not uncommon to witness in-the-money call options being exercised on the day prior to the ex-date.
Dividend date definitions
1. Declaration Date
The declaration date is the day that the company declares that it will pay a dividend. With this declaration, the company announces how much it will pay, the ex-dividend date, and the payment date. The declaration date is sometimes called the “announcement date” and most reliable dividend-paying companies keep to a regular declaration schedule.
2. Ex-dividend Date
As of the ex-dividend date, buyers of this stock will no longer be entitled to receive the declared dividend and the stock is said to thereafter trade “ex-dividend” (without dividend). In other words, shares must be owned prior to the ex-date. Before trading opens on the ex-dividend date, the exchange marks down the share price by the amount of the declared dividend.
As an example, BCI, Inc. declares a $0.50 dividend with an ex-dividend date of November 10th. Anybody who buys the shares on the 7th, 8th, or 9th—or any date prior to the 10th—will receive that dividend. When the stock opens on the 10th, it will be adjusted down by $0.50 from the 9th’s closing price. Anybody who buys on the 10th or thereafter will not be entitled to receive that dividend.
As long as a stock is purchased prior to the ex-dividend date, we can then sell the stock any time on or after the ex-dividend date and still receive the dividend. A common misconception is that investors need to hold the stock through the record date or pay date.
Ex-dividend dates are, therefore, the most important date to consider whenever buying a dividend-paying stock.
3. Record Date
The record date is simply the date where the company looks at its ledger and determines to whom they send the dividend checks (“the holders of record”). The record date is always the next business day after the ex-dividend date. This date is unimportant for dividend investors, since eligibility is determined solely by the ex-dividend date.
4. Payment Date
The payment date (or “pay date”) is the date on which a company actually pays out its dividend. Generally speaking, this date falls about two weeks to one month after the ex-dividend date.
Location of ex-dividend date data in our Premium Stock Reports
Why do special 1-Time dividends sometimes have ex-dividend dates after the pay date?
What are special dividends?
Special dividends are extraordinary one-time dividends paid by a firm, often following quarters where profits are exceptionally high, or where a firm sells a division or otherwise raises a substantial amount of unneeded cash. Special dividends are a way of returning cash to investors directly, often in place of a share buyback.
Why reverse pay date and ex-date?
Firms sometimes do this so that the stock’s price is not unfairly compromised. In particular, if the special dividend is a large fraction of the overall share price, then if a stock is sold to a buyer after the ex-dividend date, but before the pay date, then the seller is entitled to the dividend, but has not received it. This means the seller is in the position of having to collect the dividend from the buyer in the future. For large special dividends, these issues can be avoided by having the payment occur before the ex-dividend date.
Significance to dividend capture investors
Having the payment date ahead of the ex-dividend date does not fundamentally change the economics of the dividend. The stock price is still adjusted on the payment date, and that means shareholders may be able to benefit from buying the stock ahead of the dividend, if the stock’s price does not fall by the same amount as the dividend. Investors need to be sure that they do not sell the stock until after the ex-dividend date. If they do, they might have to pay the dividend to the buyer of the security. The lesson for investors here is to pay careful attention to dates when trying to capture special one-time dividend payments.
Discussion
For covered call writing, dividends play a secondary role. There is nothing wrong with trying to capture a dividend along with our option premiums and potential share appreciation when using out-of-the-money call options. However, it should not be the main focus of our trades. I consider dividends “icing on the cake”
The bottom line of this article is that the main reason for early exercise of our covered call options is ex-dividend dates. This is a rare occurrence but when it does materialize, it will be on the day prior to the ex-date. This becomes a factor when we trade in non-sheltered accounts and the shares are of a low cost-basis as exercise may result in negative capital gains tax issues.