Shares Magazine 22-1-2004

In last weeks interview with professional trader David Anderson, we mentioned opportunities that arise when a stock goes ex-dividend. Here Mike Boydell of MoneyAM explains how dividend trading works

Logically, if you hold a share and take the dividend, what you gain with one hand you lose with the other because the value of the stock should drop by the dividend amount. But it does not always work out like that in fact, the arithmetic rarely squares exactly.

Many active traders exploit this anomaly by taking a position on a Tuesday and closing out on a Wednesday, taking profit from the dividend/stock movement over a single day.

On the MoneyAM Traders Room, many active traders post messages showing traders and lurkers some of the tactics they employ during each and every trading day. David Anderson who goes by the user name Crocodile is a proponent of dividend plays and regularly posts what to look out for and shows his live trading style.

So what is it all about? Companies in the UK go ex-dividend on a Wednesday, which means that on that day anyone buying the stock will not benefit from the dividend payment. Someone buying on the Tuesday will, of course, receive the dividend.

In a normal flat market, the share price for a stock going ex-dividend will usually open at a price lower than the previous days close. For example, if XYZ stock closes at 120p on Tuesday and goes ex-dividend on Wednesday with a 7p pay-out, the stock should open at 113p. Well that is the theory, but markets tend not always to follow textbooks and it is these aberrations that traders love to expose.

So what should a good trader do? Dont forget the costs a trader, just like any normal investor, still has to pay commission on the trade plus stamp duty if using a cash account. On a contract for difference (CFD), of course, trading will be duty free. Some brokers now are very cheap charging less than 10 per trade and some do not even charge on a CFD. On CFDs, though, the broker will possibly reduce the amount of dividend he passes on to you, normally to 90% gross.

Lets take some examples. The table lists stocks that went ex-dividend over a short period last year.

First lets narrow down the list to find stocks that are worth playing say, stocks paying a good dividend of over 3% and with a tight bid-offer spread. The highlighted entries in the table make the selection more manageable.

Next, a trader might employ different tactics in rising and falling markets. In a rising market, he might buy the stock long on the Tuesday and hope that the price will fall the next day by less than the value of the dividend. Five of our six stocks would have made you money using this tactic, with an overall gain of between 1% and 5.54%. Not bad for 24 hours work.

Out of interest, on 1 October, the FTSE rose 77 points, on the 8th it was down 3.8 points and on the 22nd down 67 points. Obviously, the stronger the market, the better the return on the day. In some cases, closing out at open on the Wednesday would have boosted the profit.

In a falling market, a bearish stance would be taken. In other words, the trader would sell the stock short on the Tuesday, again hoping that the share price would fall in line with the dividend and more, and then buy back on the Wednesday. However, in the case of a short position across this period, you will have to pay the dividend rather than receive it.

Take Hays from our sample: the sequence on a short position would be that you sell the stock at 124.5p, pay the dividend of 5.38p and buy back at 118.5p, giving you a profit of less than 1p. Not worth the bother I hear you say, and you would be right as you still have to pay commissions etc. But in a strongly trending market, the tactic will normally work.

Well that is the simple bit, but traders will often look for other aberrations and opportunities. In a bear market, they will often see what price the stock opens at on the Wednesday. If it has hardly fallen at all, they will short, expecting the stock to drop more as people unwind their positions. Conversely, in a bull market, a trader will see if the fall is overdone on a Wednesday and might buy long, expecting the stock to recover during the session.

Mike Boydell is managing director of MoneyAM. He is also a director of Global Markets Training and Traderpc and has been an active private trader in the UK for 13 years.