Dividend Rollover Plan

What Is a Dividend Rollover Plan?

A dividend rollover plan—also known as a dividend capture strategy—is an investment strategy in which the investor purchases a dividend-paying stock shortly before its ex-dividend date. The investor then sells the shares shortly after the dividend is paid, hoping to secure a short-term income stream.

How a Dividend Rollover Plan Works

Users of the dividend rollover plan hope to generate income from the dividend payment while quickly recoupling most or all of their capital investment from the sale of the shares. In practice, however, the dividend rollover plan is not reliably effective. This is because, in most cases, the price of a dividend-paying stock will decline after the dividend is paid, by an amount equal to the dividend payment. 

If this occurs, then the investor would secure a small loss on the sale of the shares, offsetting the gain from the dividend and producing a break-even transaction. In such cases, the strategy may be unprofitable on a net basis, after accounting for trading fees and tax implications.

A trader looking to implement a dividend rollover plan would do so by following these steps:

1. Choose a stock with an upcoming dividend.
2. Purchase that stock before the ex-dividend date.
3. The trader can sell on or after the ex-dividend date, but not before.
4. On the date of record, the dividend is then assigned.
5. Later, the dividend is paid out on the pay date.

Traders who use this strategy do so because it is simple and they are hedged, although only slightly, by the dividend payout. Some investors will only use this strategy if they are comfortable holding the stock after the ex-dividend date.

A variation of this strategy is to bet on the price falling after the ex-dividend date. There is usually a small pullback on the share price as traders and investors capture the dividend and then sell. These small price movements can be taken advantage of by options traders, who will buy puts on a stock the day before the ex-dividend date, selling the puts possibly even the next day. This is a much riskier strategy than simply buying the stock and selling it after capturing the dividend.

Dividend Timeline

Investors utilizing a dividend rollover plan pay attention to four key dates:

• Declaration date: The board of directors announces dividend payment. This is the date when the company declares its dividend. It occurs well in advance of the payment.
• Ex-dividend date (or ex-date): The security starts to trade without the dividend. This is the cut-off day for being eligible to receive the dividend payment. It's also the day when the stock price often drops in accord with the declared dividend amount. Traders must purchase the stock prior to this critical day.
• Date of record: Current shareholders on record will receive a dividend This is the day when a company records which shareholders as eligible to receive the dividend.
• Pay date: This is the day when the dividend is paid and the company issues dividend payments

The time that an investor is required to hold the stock is only until the ex-dividend date. They can either sell it on that date or, if they feel there is a further upside, they may keep it. This depends on their individual investing strategy. Generally, the type of short-term traders who will use a strategy like this will only hold the stock if it fell in price. They would then sell it at the price they paid for the stock, as the profit already exists in the form of the dividend.

Dividend Rollover Plans and Taxes

The ease of this trading strategy is offset by its taxes. Dividends come in two forms, qualified and unqualified dividends. In order for a dividend to be qualified, it must meet certain criteria. What excludes dividends captured from a rollover strategy is the minimum time requirement for dividends to be held in order to be considered qualified. This period of time is 60 days before the ex-dividend date.

Because the dividends that are paid to investors who use this strategy are unqualified dividends, they are taxed at the Internal Revenue Service's (IRS) income tax rate. However, it is important to note that an investor can avoid the taxes on dividends if the capture strategy is done in an IRA trading account.

Example of a Dividend Rollover Plan

To illustrate, consider the case of a dividend-paying company that announces that it will distribute a dividend of $2 per share, with an ex-dividend date of March 16th. An investor using the dividend rollover plan could buy shares in the stock on or before March 15th, and then sell the shares on or after March 16th.

Although this transaction would effectively “capture” the $2 per share dividend, whether the transaction is profitable on a net basis depends on the movement in the company’s share price, as well as other factors such as the investor’s transaction costs and tax position.

Price Moves

For instance, suppose the company’s shares trade at $25 and only decline to $24 following the payment of the dividend. In that scenario, the investor might hope to generate a profit of $1 per share on the transaction: buying at $25, receiving a $2 dividend, and then selling for $24. To the extent that the investor’s transaction fees and tax liabilities add up to less than $1 per share, then this strategy could be viewed as successful.

If, on the other hand, the share price moves to $23 or lower following the dividend payment, then the transaction will have been a failure. After breaking even on the gross proceeds, the investor would take a loss after accounting for their other costs.

Another factor weighing against the dividend rollover plan is the issue of risk. In the above examples, a prudent investor would demand some risk premium to reflect the fact that they cannot predict with certainty how the share price will move following the dividend. It is entirely possible, for instance, that the share price could move below the $23 breakeven point—due, for instance, to negative news unrelated to the dividend payment.

For these reasons, users of the dividend rollover plan should be careful to only apply the strategy to companies whose historical post-dividend price movements have consistently demonstrated that the strategy will likely be viable.

The Bottom Line

Investing in a dividend rollover plan has the benefits of being simple to understand, requiring no technical or macro analysis. However, your dividends will be taxed at your normal income rate, and there is always the risk that the stock drops on the ex-dividend date, and selling the stock would eliminate any gains made on the dividend.