In a recent email from a student I was asked about the peculiar price action for a stock as it was preparing to pay a dividend. While looking at the chart of the stock I was reminded of a trading strategy that is not commonly followed. The strategy, “surfing for dividends,” is not common as it is not necessarily a high probability opportunity and should not be practiced by novice traders.
When a company is to share profits with its shareholders they 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 ex-div date will receive the dividend. Anyone purchasing the shares on the following day 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.