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A long futures position will not entitle you to dividends on the underlying stock unless you could take delivery of the stock under the futures contract when the ex-dividend date is after contract expiry. This week, we discuss if it is possible to capture dividends when the ex-dividend date on the stock is before contract expiry.
Dividend capture
Most traders do not prefer dividends, as tax on dividends is higher than the tax on trading gains. Note that trading gains from futures and options are taxed as business income, not short-term capital gains as is the case with delivery trades in the spot market.
Let us suppose you want to capture dividends. The issue occurs when you are long on futures and the ex-dividend date on the stock is before contract expiry. You must buy and hold the shares to be eligible to receive the dividends. The proceeds can come from closing your long futures position before the stock turns ex-dividend.
If dividends account for more than 2 per cent of the market value of the stock, NSE will adjust the futures price to the extent of the dividend. Take NMDC, which recently declared a dividend of 5.75 per share. This stock went ex-dividend on February 27. Suppose the futures price was 240 prior on the last cum-dividend date. Then, adjusted futures price the next day will be 234.25. This means you do not capture any benefit holding the futures, as dividends are backed out of the futures price. But if you want to capture the dividends, you should switch from a long futures position to a long stock position. You must do this on the last day the stock trades cum-dividend. Because the NSE will adjust the futures price the next day, the futures price will be trading at a discount to the spot price when you sell the contract. That discount is likely to be close to the dividend amount.
So, what is the advantage of buying futures over buying the stock in the first place? Leverage. You will not use large trading capital to buy the stock till the last cum-dividend date. As futures contract requires only initial margin and mark-to-market margin, you can gain exposure to the number of shares defined by the permitted lot size for a fraction of the capital required to buy the same quantity of shares in the spot market. This allows you to use the capital to initiate other positions in the derivatives market till such time.
Optional reading
The closer the last cum-dividend date is to the expiry of the futures contract, the closer the futures discount (relative to the underlying) will be to the dividend amount. Note that it may not be optimal to switch from futures to the stock if the futures discount is greater than the dividend amount. On the other hand, you will gain if the discount is lower than the dividend amount.
The author offers training programmes for individuals to manage their personal investments
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