The Dividend Capture Covered Call Collar, is the options trading strategy that traders can use to protect an existing position that has recently surged into a key resistance level and is about to pay a dividend. Rather than simply taking profits on the share position and potentially missing out on the dividend and future upside, the trader enters into a Dividend Capture Covered Call Collar. This options trading strategy seeks to protect your existing share position while still participating in some of the upside, including the dividend, for a modest outlay.
The Dividend Capture Covered Call Collar allows you to participate is some of the future gains up to the sold strike price and hopefully the dividend, while being protected by the put position.
Dividend Capture Covered Call Collar – is ideal for participating in future gains and picking up the dividend, while being protected on the downside.
If you are of the opinion that the stock market is likely to sell-off and the share has little chance of breaking the key resistance level, but you still want to hold on to it for the dividend, you could use a Dividend Capture Covered Call Collar options strategy. The Dividend Capture Covered Call Collar strategy is similar to the protective put options strategy in that you also buy put options as protection. The difference is that you will now finance the purchase of those put options with the proceeds from writing an equal number of out of the money call options.
The position will still protect you from losses below the strike price of the put options at minimal cost to yourself, but it will stop the position from profiting beyond the strike price of the short call options should the stock stage a rally and you could miss out on the dividend if this rally happens before the Ex-dividend date. That is you would miss out on a strong rally in exchange for putting on the protection of the put options for free (apart from commissions of course).
Use a Dividend Capture Covered Call Collar when you expect the share price to move modestly higher or pullback significantly from current levels and you want to hang on for the dividend.
Recent Trade – Westpac Bank for Dividend
A recent trade we recommended was to buy Westpac above $19.37 on September 27. This trade was intended to capture to the dividend and the share price has subsequently jump to around $22.00 where it is meeting resistance. If you wanted to hold on to your trade for the dividend, (WBC goes Ex-div $0.74 on 8th November), then you could take advantage of this Dividend Capture collar strategy**.
We entered the share position on the day of the recommendation at $19.67. The share price is now trading around $22.00 and has now been trading sideways for the past 2 weeks but it will go Ex-div $0.74 on 8th November.
Given the turmoil in the eurozone which has been triggered by the problems with the European financial system and the debt crisis, we considered a Dividend Capture covered collar was appropriate for this position. Based on technical analysis you can see from the chart that the $22.50 resistance level has held for over six months.
So we bought protection at $21.00 by buying 2100 DEC11 Put for $1.00 and then wrote the 2250 DEC11 Calls for $0.44. This trade cost 56 cents but we are protected until December expiry down to $21.00 and profits will be capped at $22.50.
Chart 1: Westpac Dividend Capture Covered Call Collar Trade
You can plan and analyse your trade as shown above, using the Derivative Profiler option in the Market Analyser software. MarketAnalyser also provides a payoff diagram for further trade analysis as follows:
Chart 2: The payoff diagram for the Westpac Dividend Capture Covered Call Collar Trade.
Westpac (WBC) is still trading between the $21.00 and $22.50 option strike levels and only time will tell where the share price will end up at expiry, but we are protected until December expiry down to $21.00, but profits will be capped at $22.50**.
Options can be used in order to reduce your risk while still participating in potential profits from a significant move by the underlying stock. We have explained the Dividend Capture Covered Call Collar strategy which is allows you to participate is some of the future gains up to the sold strike price and hopefully the dividend, while being protected by the put position.
In future articles we will talk about the High Yield Covered Call strategy and the Covered Call Stock Reversal strategy which is particularly relevant to this market.
Utilise the features in the Market Analyser software to trade plan your options trades for the particular options strategy using your specific trade selection criteria. You will save time and potentially reduce your trading risk.
By Michael Hevern
Head of Research
** Please note your may need to refer to a tax profession regarding eligibility of franking credits.
Options Trading for All Types of Market Environments (Part 1): The Protective Put
Options Trading for All Types of Market Environments (Part 2): The Covered Call
Options Trading for All Types of Market Environments (Part 3):The Covered Call Collar
Options Trading for All Types of Market Environments (Part 4): Stock Repair
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MDS Financial Advisory Services offers general advice on trading options to generate consistent steady income on your investment portfolio. Call 1300 610 024 for further information.