Buying Calls for Dividend Strategy

You may want to buy a call option when:

• The stock is about to run up, particularly for large special dividends right before ex-dividend, and
• There is risk of sudden drop, either because of weak fundamentals, a major news or event occuring during the run up, or because the stock has been on a sustained downward trend.

Should I buy a Call instead of going long?

Options are expensive. To benefit from options, you need meaningful gains. Hence better not to use options on dividends less than 5%, since the run up is much weaker.

In addition, when buying options you pay a sort of "insurance premium" to edge yourself against the risk of stock drop. Make sure you need this insurance. So ask yourself the following questions:

• Is there an important event that may break the upward momentum right before ex-dividend or right after the dividend announcement? Look for possible financial results announcements, important shareholders meetings or court ruling.
• Has the stock been on a consistent downward slope until the dividend announcement? Often management announce special dividends or dividend hike right before weak results in order to break a downward momentum. It sometimes buy them time to put their house back in order, but in about 70% of cases any run up would prove short lived.
• Are the fundamentals weak? Low PEG make the stock more likely to see a drop in case of news or if short sellers start smelling blood. In our sample, half of the companies that saw 5%+ drop during what should have been the run up period had weak fundamentals.

When should I buy the Call Option?

You want to hold on a Call option as little as possible. Call options experience time decay, so better to buy at the beginning of a run up phase, and sell right when the upward momentum is dying or the risk factor is eliminated.

Usually, you want to buy Options at the strike price that closest to the stock price at the time you buy (help).

The expiration date does not matter much, since time decay applies linearly. As long, of course, as the option expires after the run up (for example after exdiv), or at least after any risky event that prompted you to buy a call option in the first place.

Reality check: Don't buy a Call if...

• The dividend is less than 3%. Yep, that means no call on about all regular dividends. If you see a risk there, simply move to the next stock.
• You want to win big. Dividend Strategy is about many small gains. If you are after the 10-bagger, you no longer play Dividend investing. If you are short of cash, get back to basics: long or short only.