I was trying to find a strategy to earn the dividend of the stock without taking the risk of the fall in the stock price. Below is the trade:
Buy 100 MO at $16.50 = $1650 debit
Sell 1 January 2010 $5 strike call for $11.10 = $1110 credit
Net debit = $1650 - $1110 = $540
Current dividend yield = $0.32 per quarter
At the expiration in January 2010, if the stock is above $5, the option will get assigned and the stock will be sold for $5 = $500 credit. The net loss on the stock = $540 debit - $500 credit = $40
Dividend earned = (((0.32*4)/3)*2)*100 = $85 (prorated
dividend for about 8 months)
Total profit = $85-$40 = $45 ~ 8.5%
The trade will not make money in the movement of the stock. It will only make money as dividend.
The trade will lose money in two situations:
1) If the stock price is below $5 at expiration - a possible but very unlikely scenario.
2) If the company cuts the dividend. Again, an unlikely scenario for a company like MO.
In both of the above cases, the trade can be settled even before the expiration date without any major risk to the position.
I would really appreciate if somebody can help me verify this trade.
This is an impossibility.
If you buy stock and pay $16.50 and then immediately turn around and sell that same stock and collect $16.10, how do you anticipate earning any money?
What will you do if the call owner exercises the calls the day before MO goes ex-dividend? You will lose the stock, collect zero dividends, and be out the $40 you gave away, plus commissions.
Thus, the very first thing you must do - if you attempt this trade - is to be 100% certain that you do not sell the calls under parity. That means not selling them below their intrinsic value. If the stock is $16.50, then the intrinsic value is $11.50. My guess is that no one will be willing to pay that much and that you cannot execute the trade without throwing cash in the trash.
Next, if you think it's a good idea to own stock and be short the Jan 5 call, don't you think that others will think the same way? Won't the intelligent market maker who buys your calls exercise them to collect the dividend? Yes, he/she will.
For your plan to work, you need an ignorant person to buy those calls, and then fail to exercise for the dividend. Possible? Perhaps, but not very likely.
Mark D. Wolfinger
The Rookie's Guide to Options:The Beginner's Handbook of Trading Equity Options
Free eBook: http://www.mdwoptions.com/freebook.pdf