As we enter earning season once again, I have received several emails about what to do while trading stocks that release earnings. I would like to address one such email.
Would it be possible to discuss the following topic in an upcoming, Lesson From The Pros concerning the following:
DIVIDEND STRIPPING and its relationship with supply and demand:
1. Define dividend stripping?
2. Are all stocks which give dividends candidates for dividend stripping?
3. How can someone apply the supply/demand technique to obtain the dividend and profit from the change in price of a stock before and after it goes ex-dividend.
I will refer to an older article I wrote called “Surfing for Dividends,” as it answers many of these questions. The strategies of, “surfing for dividends,” or “dividend stripping,” are synonymous and are not very common as they are not necessarily high probability opportunities and should not be practiced by novice traders.
To share profits with its shareholders, a company may elect to do it in the form of a dividend. The payment of a dividend is usually announced when the company releases their quarterly earnings report. At that time, they will also note several important dates: the Ex-Div Date, the Record Date, and the Pay Date.
The record date is when the company officially records who should receive the dividends and is not that important to the shareholder. The pay date is the day that the dividends will be paid to shareholders. However, the most important date is the ex-div date. This determines who gets the dividend from the company. A person who holds the shares in their account at the close of the markets on the day preceding the ex-div date will receive the dividend. You would have had to have purchased the shares the day before the ex-div date to get those dividends. Anyone purchasing the shares on the ex-div date will own the shares but not receive the dividend. That is why ex-div means excluding the dividend.
Since the shares will be bought without the dividend after the ex-div date, the share prices will typically gap down the amount of the dividend. For example, if a $30 priced stock were to pay a $0.40 per share dividend, the price should open with a gap down to $29.60 on the morning following the ex-div date.
This gap down is sometimes temporary. If the stock is a strong one or if the markets are bullish, there is a chance that the gap will close. This means that a person who bought on the ex-div date could sell their shares for no loss or even a small gain and then still collect the dividend. This is called surfing for dividends.
Looking at the chart of Rockwood Holdings Inc., (ROC) you can see that the stock gapped down dramatically on May 30th. This was the ex-div date for a $0.40 per share dividend. Price closed at $67.42 on the 30th and opened at $66.50 on the 31st. Obviously, the stock gapped down much more than the dividend amount. On the 31st, price rallied in the morning until it was trading above the ex-div closing price. A savvy trader who bought for the dividend could have sold and made some money on the trade as well as received the dividend as a bonus!
Immediately after closing that gap, ROC’s price dropped dramatically as traders did just that. Surfing for dividends is not always going to work. You still want prices to gap into a demand zone for the highest probability for the trade to work. You do not want to get stuck holding onto the stock for another quarter while waiting for price to recover.
I shared this information with you to explain price action around ex-div dates. Do not try to trade this phenomenon without having experience and a solid trading plan in place. To learn more about how to trade these dividends, I suggest that you join us in the Extended Learning Track of Online trading Academy.