Dividend Arbitrage

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DEFINITION of 'Dividend Arbitrage'

An options trading strategy that involves purchasing put options and an equivalent amount of underlying stock before the ex-dividend date and then exercising the put after collecting the dividend. When used on a security with low volatility (causing lower options premiums) and a high dividend, dividend arbitrage can create profits while assuming very low to no risk.

BREAKING DOWN 'Dividend Arbitrage'

For example, suppose that stock XXX is trading at $50 and is paying a $2 dividend in one week's time. A put option with expiry three weeks from now and a strike price of $60 is selling for $11. A trader wishing to structure a dividend arbitrage can purchase one contract for $1,100 and 100 shares for $5,000, for a total cost of $6,100. In one week's time, the trader will collect the $200 in dividends and the put option to sell the stock for $6,000. The total earned from the dividend and stock sale is $6,200, for a profit of $100.

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RELATED FAQS
  1. Short selling vs. purchasing a put option: how do the payoffs differ?

    Purchasing a put option and entering into a short sale transaction are the two most common ways for traders to profit when ... Read Full Answer >>
  2. How is a put option exercised?

    A put option is a contract that gives the option holder the right, but not obligation, to sell a set amount of shares (1 ... Read Full Answer >>
  3. What's the difference between a regular option and an exotic option?

    Before learning about exotic options, you should have a fairly good understanding of regular options. Both types of options ... Read Full Answer >>
  4. Do penny stocks pay dividends?

    Because of the small market capitalization and revenues typical of most penny stocks, there are very few that offer dividends. ... Read Full Answer >>
  5. How do dividend distributions affect additional paid in capital?

    Whether a dividend distribution has any effect on additional paid-in capital depends solely on what type of dividend is issued: ... Read Full Answer >>
  6. Is there a difference between financial spread betting and arbitrage?

    Financial spread betting is a type of speculation that involves a highly leveraged derivative product, whereas arbitrage ... Read Full Answer >>

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