I am sure that you’ve heard Costco Wholesale (COST) announced a special dividend of $7.00 per share, plus an additional increase of $0.05 to its regular quarterly dividend.
The special $7.00 one time cash payment will be paid on May 26th, to those who are on record as owning shares on May 8th, 2017.
What do we expect to happen when a special dividend is paid? Well, we expect the COST share price to fall -$7.00 to reflect the $7.00 one time payment.
So, is this a Free Money investment if I were to buy an Out of the Money or At-the Money put option? Since the stock is going to fall the put would have to gain in price, correct? Even though I did not receive the dividend, my put would still gain and I would have a nice, juicy, leveraged profit…right?
Not quite. In fact, not at all. In addition to expecting the stock to fall 7 points when the dividend is paid, the Strike Prices of the existing options will also adjust 7 points to reflect the special payment.
For example, today, May 4th, 2017 – COST is trading at $182.36.
I could buy an At the Money 02-JUN $182.50 put at $3.45 per contract.
If COST remained at the same price, on May 8th we would expect the stock to fall to $175.36 to reflect the Special Dividend.
My 182.50 strike put would be worth $7.00 minimum in intrinsic value, so this would be a no risk +100% gain!
Unfortunately this is not the case. On May 8th my 02-JUNE 182.50 put would automatically become a 02-JUN 175.50 strike put to also compensate for the $7.00 payment.
The bid-ask of my 182.50 put the moment before the dividend is released would be equal to the bid-ask of my new 175.50 put the moment after the dividend is released.
My liquidation value just before the dividend release would be equal to my liquidation value just after the dividend is released. The gain or loss I would have on this option trade would be based on the stock performance alone from today to May 8th.
This same principle applies to a Married Put. If I purchased COST at $182.36, and at the same time bought the 02-JUN 185 put for $4.75, I would have a 5-Line Setup of:
Buy 100 shares COST at $182.36
Buy 1 02-JUN 185 put at $ 4.75
Total Invested = $187.11
Guaranteed Exit = $185.00
Maximum Risk = $ 2.11, or 1.1%
“So, when the dividend is paid, I collect $7.00 and have a guaranteed profit of $4.89 ($7.00 – $2.11), right?”
Again, no. On May 8th the stock would fall -$7.00 to compensate for the special dividend. Also on May 8th your 185 strike protective put would become a 178 strike put. The maximum loss on the position would still be $2.11, or 1.1% – even factoring in the $7.00 Special Dividend payment.
But hey, if you are long term bullish on COST, you want to take advantage of the Special Dividend AND the increased quarterly dividend over time – consider using a long term married put as outlined in the RadioActive Trading techniques for limited risk trading.
There is no free money with a Special Dividend payout, but you can still control your risk, take advantage of a bullish sentiment and further dividends with a proper limited risk structure in place.
Click HERE to view The Sketch, the free white paper introducing how to properly limit your risk on any stock.
Other Resources on Special Dividends:
Click HERE to see our previous webinar on Special Stock Dividends (the screen display starts about 10 seconds into the video – sorry about that!)