Here's the theory: Take a stock, XYZ, trading at $10/share. It's next-expiry $8 call costs $2.25 ($2.00 intrinsic value plus $0.25 time premium). XYZ has announced a $0.50 dividend payable to shareholders of record the day before the ex-dividend date.
Entering into a covered call position means buying 100 XYZ shares ($1,000) and selling 1 XYZ call contract ($225) leaving a net debit of $775.
On the ex-dividend date, the stock will drop by the dividend amount, in this case to $9.50.
So the trader's long position drops in value to $950, but the short position drops as well to $175.
In closing the position, we sell the shares for $950 and re-buy the calls for $175.
So the total trades were:
- Buy 100 XYZ (-$1,000)
- Sell 1 $8 XYZ (+$225)
- Sell 100 XYZ (+$950)
- Buy 1 $8 XYZ (-$175)
The total of these trades was zero.
But, since we held the stock at the close before the ex-dividend date, we qualify for the $50 dividend.
A $50 gain on the $775 net debit is a 6.5% return, which is not bad for one day's work.
My first attempt was with INTC.
I bought 200 shares at $25.80 ($1.00 commission) for a total of $5,161
I sold 2 Aug03'12 $25 calls for $0.80 ($1.52 commission) for a total of $158.48
But since there was no time premium in the call, it was assigned away.
And on the assignment, Interactive Brokers charged me $0.11 commission, netting me $4,999.89
So my net was -$5,161.00+$158.48+$4,999.89 = -$2.63
Oh well. Three dollars was not a very expensive lesson.
