A dividend-arbitrage trade, often referred to as a dividend trade, takes place between professional market makers who buy and sell thousands of options as part of a strategy that allows them to collect corporate dividends on the stocks.
The goal of such a trade is to capture the (usually quarterly) dividend that companies issue to investors. The trade takes place on the day before a stock goes ex-dividend, which is the day on which a company compiles a list of its shareholders for the purpose of issuing a dividend.
Market makers who want to capture that dividend without becoming long-term stock owners will buy and sell call options. In doing so, they take both long and short positions in the same contract. They increase their odds of capturing the dividend if they buy and sell hundreds of thousands of options. As a result, they increase the trading volumes for exchanges on which the transaction is conducted.
The International Securities Exchange has taken exception to the practice, saying it distorts the relative volume numbers at the U.S. options exchanges, inflating the market share of exchanges on which the transaction takes place. The dividend-arbitrage trades take place only on trading floors. ISE is an all-electronic exchange.
A trading unit of Bank of America Merrill Lynch, Merrill Pro, reportedly lost close to $10 million on a dividend trade on September 21, 2012 due to an error in handling or processing the trade, according to a Dow Jones story.
- BofA Merrill Lynch Takes Loss Linked to Error on Options Trading -Sources. Dow Jones.
- Danger Sign? Popular Trade Has Exchange Raising Alarm. The Wall Street Journal.
- Nasdaq to 'dominate' U.S. equity options. MoneyCentral.