CFD Strategy 4: Dividend Capturing Strategy

OK, let us talk about one of my favorite CFD trading topics ‘” dividend capturing strategy. In today’s market, where interest rate remains very low ‘” although dividends have been cut ‘” it is still likely to have a positively geared portfolio.

There are 2 ways to benefit from dividends using CFDs ‘” a simple way and a harder way.

I like to stick to my KISS-P (Keep It Simple & Stupid & Persistent) principal for everything I do ‘” as I tend to come up with creative and innovative ideas every now and then, it is better to stick to simple ideas and just repeating it everyday.

Simple Strategy: Follow the yield

The simple strategy is using the leverage to buy into stocks that pay higher dividend yield than your financing cost.

Remember, you are not paying the full interest on your position – depending on your particular stock, let us use 90% margin for instance.

· Use average Australian property trust company for instance

· Assuming you have bought $5,000 worth of shares

· Less than the 10% margin which is $500

· Paying interest on $4500

· Average interest is around 6.8%

· Dividend is at 8%

· Interest payable: $306 each year

· Dividend to receive: $400

· Net gain is actually $94 in this case

Of course share prices do move up and down ‘” but in the current low interest environment, you can use CFDs for positive gearing ‘” which means the dividend will cover the interest.

There are a number of factors you have to be mindful of:

1) Variable interest ‘” CFDs are based on variable interest rates, this means they can rise very fast and the positive gearing effect will disappear very fast

2) Interest will go up as the underlying positions go up ‘” that is right, this means your financing cost is not a fixed rate ‘” as the share price goes up, the cost will go up as well

3) Special Dividends ‘” special dividends can bring opportunities, but in most cases, once the special dividend is paid, the share price tends to drop considerably ‘” often much more than the actual dividend amount.

4) Franking Credits ‘” remember, franking credits are not passed on in CFDs, so if you are looking for tax effective dividends, this will not work.

I have applied this strategy particularly on property trusts many times ‘” but I have put a hold on this strategy in early 2009 as increasing number of property companies have suspended their distributions ‘” now the market seems to have stabilized a bit, I think it will be a good time to implement this strategy again.

A Harder Strategy ‘” Trade High Dividend Stocks

A more active strategy is to trade more regularly ‘” so called Dividend Capturing Strategy or Dividend Stripping Strategies.

The strategy based on the theory that stocks, especially large cap stocks with good franking levels typically go up prior to the ex-dividend date, traders therefore focus their trading activities around the ex-dividend dates on these companies.

The strategy depends on what you want to do towards the ex-dividend date ‘” for me, if there is a substantial return, say 10% to 20% in the share price (which equates to 100% to 200% based on your margin), I would take the profit instead of waiting for the dividend.

Some will wait for the dividend; then your net return is based on:

Share Price Increase + Dividend – Loss on ex-dividend date.

The latter (loss on ex-dividend) is a real wild card ‘” recently, I was trading on a stock, the stock rallied 10% on the last 3 days prior to the ex-dividend date, the dividend was 3.5% (semi-annual dividend), the stock dropped 5% on the ex-dividend date. So the net return was 10%+3.5% – 5% = 8.5%, not a bad return on a 3 days trade.

The real problem is ‘” if they drop more, then you will end in a net loss position. Conversely, I was also very fortunate twice, where the market rallied on the ex-dividend date, and I received both the dividend and capital growth on the same day, this, however, does not happen very often and you need an exceptional market rally day to achieve this.

For even more active traders ‘” they will take profits and then enter into a short position on the day right before the ex-dividend date; this has worked for me a number of times.

The real issue about dividend trading strategy is liquidity, this will not work on illiquid stocks, and it will not work on relatively low-yield stocks as it does not justify the effort.

In my experience, it has worked the most effectively on financial stocks especially the banks, and I am also starting to see it can also work on certain property trusts, once they are stabilized in the current market.

For most investors, they apply this strategy to the big banks ‘” but this means relatively limited choices when comes to trading opportunities, and you can only apply the strategy twice a year based on their dividend date pay out dates.