ex dividend trading strategies

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Trading around the ex-dividend date of a company is a popular idea with traders. There are numerous ex-dividend trading strategies aspiring traders employ and some of them offer the potential of lucrative rewards, particularly if you are using CFDs or spread betting. At the same time however, trading around the ex-dividend date is not quite as easy as it may sound and there are some potential pitfalls. Let’s have a look at some strategies you can use and their respective advantages and disadvantages.

 

What Is the Ex-Dividend Date?

Before we get into discussing the individual strategies, let’s first make sure we understand what we mean by the ex-dividend date. In short, a number of companies on the stock market pay dividends. These are typically paid twice per year in the case of UK companies on the FTSE and AIM markets and four times per year in the case of US companies. To qualify for these dividends, you have to be an owner of the shares on a particular date. This is what is known as the “ex-dividend date” (or XD for short).

The ex-dividend date is usually on a Wednesday (in the case of UK companies) so to qualify for the dividend you need to be a holder of the share at the market close on the Tuesday. Then the company will go “ex-dividend” the next day and the share price will normally drop by the amount of the dividend. So if the dividend is 5%, the share price will normally drop by 5%.

However, there is no hard and fast rule about this – sometimes it drops by more and sometimes less. Other news and market conditions can also play a role in how much the share price drops by on ex-dividend date.

Normally two days after the ex-dividend date comes the “record date,” when all shareholders due to receive the dividend are noted on the record. However, you do not actually need to still hold the shares on the record date – this is a common misconception. As long as you held the shares at the close on the day before the ex-dividend date, you will be entitled to the dividend payout even if you sell the shares on the ex-dividend date or the day after.

Finally there is the actual payment date when shareholders receive the dividend payment into their shareholding accounts. This is normally six weeks to two months after the ex-dividend date.

So in summary you have:

  • the Declaration Date, when a company announces it will be paying a dividend;
  • the Ex-Dividend Date, when you must be holding the stock to qualify for the dividend;
  • the Record Date, when all shareholders on the ex-dividend date are noted on the record;
  • the Payment Date, when shareholders receive the dividend payout. 

How Do Spread Betting and CFDs Handle Dividends?

The good news is that the vast majority of spread betting and CFD brokers do account for dividends, so you are not missing out compared to holding the shares in a traditional way in terms of dividends. In fact you normally receive the dividend much sooner through spread betting/CFDs, often as soon as the stock goes ex-dividend rather than having to wait six weeks to two months.

With spread betting/CFDs you normally receive approximately 90% of the dividend value, with the other 10% being deducted equivalent to the nominal rate of tax.

If you have shorted the stock in a spread bet/CFD, you would have to pay the equivalent of the dividend payout and this will be deducted from your account. So before you think this would be an easy way to make money by shorting a stock before the ex-dividend date, sadly that is not a viable option. Those clever brokers have thought of everything!

OK, so now we’ve had a look at how things work in terms of the ex-dividend date, let’s lay out some strategies in relation to trading around it.

 

Strategy One – Trading in the Run-Up to the Ex-Dividend Date

One of the main strategies for trading stocks around the ex-dividend (XD) date is to buy them in the run-up to the date in the hope they will rise. Often just the anticipation of the upcoming dividend will tempt people to buy in and shares can rise into the XD date as a result. Just how long you should buy before the date – and whether this might be profitable – is another question altogether though.

One study looked at the results of trading in the run-up to the XD date on 29 stocks on the Dow Jones from 2013 to 2019 and found that there was an upward drift in price as the XD date approached, even allowing for hedging (i.e. taking into account the overall movement of the market at the time). The article looked at four ways of trading the run-up to the XD date and found that the best was to “buy the stock a day after the declaration date and hold it until the day before the ex-dividend date.”

It noted however that the length of this period varies by company and that earnings also tend to be released at the same time as declaration dates, meaning that positive earnings releases could explain at least some of the rises seen in the run-up to XD day.

 

Strategy Two – “Dividend Stripping”

Another way to trade around the XD date is what is called “dividend stripping” or “dividend capture,” as it is also known. This involves buying the stock the day before XD day and selling on XD day, hoping the share price doesn’t drop by as much as the dividend.

So for example if the dividend is 5% but the share only falls 4% on XD day, then you will have made a tidy profit of 1%. This profit is also increased if using CFDs or spread betting as you are using leverage, so a profit of 1% will be more like 10% in terms of the money you have had to put in (whilst remembering the risks of leverage if there was a sharp price drop and the need to ensure you have enough funds to cover such a drop).

As noted above, this scenario of a share price not dropping by the amount of the dividend does happen reasonably often, although there don’t appear to be any in-depth studies looking at exactly how often it happens and in what circumstances.

Normally however it would be considered sensible to deploy this strategy in bullish market conditions and when there are good fundamentals and earnings data around the company in question, thereby increasing the chances that the positive sentiment behind the stock will mean it does not drop by as much as the dividend percentage and thereby giving an overall profit on the trade.

A longer-term version of dividend stripping involves buying before the declaration date and then holding until the ex-dividend date. This is slightly more risky as it includes a presumption that the company will declare a dividend, where as if they don’t then the share price could drop quite considerably.

If all is well at the company, there are no problems and there is every expectation of a dividend being paid however, the trader may enter this trade expecting there to be two positive developments:

  1. A small bounce from the declaration of the dividend; and
  2. An increase in the share price in the run up to ex-dividend date (i.e. strategy one above).

The trader can either sell the day before ex-dividend date or on the date itself, hoping again that the stock price doesn’t drop by as much as the dividend percentage. Traders would also tend to use this strategy in a bull market and where the company has strong fundamentals and earnings behind it.

 

Strategy Three – Buying After the Drop

The third ex-dividend trading strategy would be to buy the stock on XD day itself, after it has dropped. This strategy is based on the premise that the share price will gradually recover to its original level as investors and traders have taken the dividend into account and believe that the price should recover to approximately the price it was around the time of the declaration date or in the run-up to the XD day.

Once again overall market conditions can play into the returns of this approach, as could any news about the company itself. There is also the question of how long to hold the stock for, weighing up the potential of greater gains by holding for a longer period against the risks of a market downturn or a piece of bad news negatively affecting the stock price.

 

Conclusion – Ex-Dividend Trading Strategies

Using dividends as part of a trading strategy is a popular idea among traders. Above we have taken a look at three different trading strategies and how they work in practice.

Dividends are an attractive proposition for many traders because they provide a fixed event around which to base a trade with known dates to open and close a trade.

As with all forms of trading, there are of course dangers and pitfalls, not least that the overall market could fall during periods of holding a stock or the stock itself could experience a drop. However, there is some evidence (cited above) to suggest that trading in the run-up to the ex-dividend date has proven profitable in the past.

There may be a temptation to do all of the strategies above, although that also runs the risk that essentially you just end buying and holding a stock for the long term as each strategy runs into the next! So it may be better to pick one or two of the approaches above if you do decide to use ex-dividend trading strategies.

As ever with any form of trading, make sure you do your own research and follow a clear trading plan with stop losses and safeguards in place and if you use leverage to only use an amount you can afford.

Finally, best of luck with your trading, if you are using ex-dividend strategies or any other!

 

 

The contents of this website are intended for educational and information purposes only and do not constitute any form of advice or recommendation and are not intended to be relied upon by you in making (or refraining to make) any specific investment or other decisions. Appropriate expert independent advice should be obtained before making any such decision. We cannot and do not offer individual investment advice.

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