Profiting from the pre-dividend mini rally?

[princeplanet]

Total newb question, so apologies in advance, ok?

So I read about "Dividend Stripping" and learned that it's a little risky as you don't always come out on top by the time you've held a stock long enough to qualify for the dividend as well as qualify for the franking credit in full. Even so, it seems people practice this and make it work for them in the long run.

My question is, if there is nearly always a mini rally in the fortnight or so prior to a big dividend pay on a Blue Chip, then why not buy it a fortnight before ex dividend and then sell it just before the ex date. Obviously you miss the dividend, but as the value of the stock will fall by the same amount as the dividend on the very next day, what have you lost? Further upside? Sure, but you also dodge further downside, and you pick up a lazy couple % in just 2 weeks.

I'm missing something right?

 

[burglar]

... Even so, it seems people practice this and make it work for them in the long run ...

... I'm missing something right?

You are not missing a lot.
You already know that it works for some people.
Find out if you are one of them.

I don't have the patience for fishing, hunting or dividends.

 

[nulla nulla]

Total newb question, so apologies in advance, ok?

So I read about "Dividend Stripping" and learned that it's a little risky as you don't always come out on top by the time you've held a stock long enough to qualify for the dividend as well as qualify for the franking credit in full. Even so, it seems people practice this and make it work for them in the long run.

My question is, if there is nearly always a mini rally in the fortnight or so prior to a big dividend pay on a Blue Chip, then why not buy it a fortnight before ex dividend and then sell it just before the ex date. Obviously you miss the dividend, but as the value of the stock will fall by the same amount as the dividend on the very next day, what have you lost? Further upside? Sure, but you also dodge further downside, and you pick up a lazy couple % in just 2 weeks.

I'm missing something right?

Done right you should be looking for three returns:

1. The dividend;
2. The franking credit; and
3. The capital gain.

To get the franking credit, you need to hold the shares for 45 clear days. In other words you need to hold the shares for 47 days minimum, inclusive of the day you buy the shares and the day you sell the shares.

The target shares should be identified from the ASX200 shares that pay a decent yield with franking credits. Put them on a watch list and monitor them on a regular basis.

Like all "systems" there is risk because you don't "know" for certain that the share price will rise in the lead up to going exdiv and recover after the exdiv fall. Some people do well out of it but as burglar says, it requires patience, a lot of homework and there is risk involved.

 

[burglar]

Done right you should be looking for three returns: ...

+1 Nice post, nulla nulla!
You say it so much better than me!
And I learnt something new about franking credits.

 

[crutch dags]

It pays to do some real analysis first. Graph the two weeks prior to the ex dividend date for any share you are interested in. You will find that the stock market is not as predictable as you think when you look over all the data from the past decade.

If there was an easy pattern like this, it would have been picked up by a professional charter who would have exploited it until it was no longer predictable.

There are a couple of scholarly papers on stock market patterns including the "Monday effect" which you can find with Google.

 

[brerwallabi]

You need to watch the holding rule too if your planning to buy and sell for the dividend otherwise you could lose the benefit of the franking credit even more so if your earning income as a beneficiary of a trust fund too.

 

[princeplanet]

Cheers for the info chaps. Been looking for some juicy upcoming divs and spotted RHG going ex div next month. I'm a little confused as to whether it's 17% or 38%, but even if it's "only" 17% (fully franked), why isn't everyone jumping on this? Surely the mortgage industry is not as risky as it was a few years back?

 

[McLovin]

Cheers for the info chaps. Been looking for some juicy upcoming divs and spotted RHG going ex div next month. I'm a little confused as to whether it's 17% or 38%, but even if it's "only" 17% (fully franked), why isn't everyone jumping on this? Surely the mortgage industry is not as risky as it was a few years back?

Because their only asset is a mortgage book in rundown, so the dividend will continue to fall. I made a killing on this a few years ago.

 

[pixel]

You need to watch the holding rule too if your planning to buy and sell for the dividend otherwise you could lose the benefit of the franking credit even more so if your earning income as a beneficiary of a trust fund too.

That only applies if the total dividend income exceeds a threshold.

Eligibility

There are restrictions on who can use franking credits. Those who cannot must simply declare as income the cash dividend amount they receive. . The restrictions are designed to prevent the trading of franking credits between different taxpayers. An eligible shareholder is one who either

Owns the shares for a continuous period of 45 days or more (not counting purchase and sale days); or 90 days in the case of certain preference shares. This is the "holding period rule". Shares must be "at risk" for the necessary period, i.e. not with an offsetting derivatives position for instance.

Or who

Has total franking credits for the tax year of less than $5000 (the "small shareholder exemption") and has not arranged to pass-on the benefits to someone else (the "related payments rule").

Thus franking credits are not available to short-term traders, only to longer term holders, but with small holders exempted provided it's for their own benefit.

The small shareholder exemption is not a "first $5000", but rather once the $5000 threshold is passed the rule is inoperative and all one's shares are under the holding period rule.

For the holding period rule, parcels of shares bought and sold at different times are reckoned on a "first in, last out" basis. Each sale is taken to be of the most recently purchased shares. This prevents a taxpayer buying just before a dividend, selling just after, and asserting it was older shares sold (to try to fulfill the holding period).

This "first in, last out" reckoning may be contrasted with capital gains tax. For capital gains the shareholder can nominate what parcel was sold from among those bought at different times.

(Details from http://en.wikipedia.org/wiki/Dividend_imputation#Eligibility )

 

[hhvinhh]

Owns the shares for a continuous period of 45 days or more (not counting purchase and sale days); or 90 days in the case of certain preference shares. This is the "holding period rule". Shares must be "at risk" for the necessary period, i.e. not with an offsetting derivatives position for instance.

Does it have to be 45 days before ex div date / record date / date payable?

 

[tinhat]

Does it have to be 45 days before ex div date / record date / date payable?

If the total of your franking credits for the financial year are less than $5,000 the 45 day rule does not apply and you don't need to worry about it. Otherwise, you need to hold the shares for 45 days but it does not matter if you buy them the day before ex-dividend date and sell them 44 days after the ex-dividend date or you buy them 45 days before ex-dividend and sell the next day. Except that if you are wanting to dividend strip then you will probably find that buying at least 45 days ahead may yield better results - all other things being equal. Of course there is always share-price movement risk.

 

[Boggo]

Does it have to be 45 days before ex div date / record date / date payable?

No, just 45 days all up.
http://www.ato.gov.au/individuals/content.aspx?menuid=0&doc=/content/00313594.htm&page=11&H11


For an individual there is $5000 limit before the rule applies, ie if your total franking credit entitlement is below $5,000.

In the case of a SMSF the 45 day rule (excluding the day of purchase and the day of sale) applies regardless of the entitlement amount.

 

[princeplanet]

Because their only asset is a mortgage book in rundown, so the dividend will continue to fall. I made a killing on this a few years ago.

OK, but what's the chance of it falling (div or share price) in the next 45 days?

 

[statisticalg]

Hmm... Any ideas if there are any implications due to Part IVA or 177EA of the ITAA associated with dividend stripping?

I wonder why the ATO website doesn't mention any of this...

 

[princeplanet]

Hmm... Any ideas if there are any implications due to Part IVA or 177EA of the ITAA associated with dividend stripping?

I wonder why the ATO website doesn't mention any of this...

Care to elucidate?

 

[tinhat]

Hmm... Any ideas if there are any implications due to Part IVA or 177EA of the ITAA associated with dividend stripping?

I wonder why the ATO website doesn't mention any of this...

My dear learned friend, I don't know what parts of the legislation made statute by the ascent of their Excellency, the Governor General apply here; or what specific rulings apply but here is the info for those of use who speak plain English, from 'the man who gets you down':

http://www.ato.gov.au/youth/content.aspx?menuid=6646&doc=/content/8651.htm&page=4

 

[statisticalg]

The ATO website states:

The purpose of the franking credit trading rules is to prevent the inappropriate use of franking credits by taxpayers who are not the true economic owners of the shares.

and provides the holding period and related payments rules to clarify its position.

However, I cannot determine whether the ITAA overrides the small shareholder exemption or if it is the other way around:

The first criteria for cancellation involves determining if there is a scheme, which you would think is automatically satisfied, as a scheme to acquire and dispose of interests (and their attached franking credits) in Australian equities to allow different taxpayers to obtain an imputation benefit is implicit in the securities of publicly traded equities. Although, in the recent Mills case, it would suggest that the dominant purpose of an equity raising is to raise capital and that the imputation/franking credits from profits of public companies are just incidental. The incidental "phrase" effectively nullifies Part IVA as stated in the ITAA itself.

However, is dividend stripping another scheme? The scheme itself doesn't allow the exchange of shares or interests, i.e. dividend stripping itself doesn't facilitate the transfer of shares. Although, it might be thought of as an unilateral scheme, even if you wouldn't know who is participating due to the execution of trades over an exchange. Compare this to deliberate matching of foreign investors to Australian investors that can access imputation credits, in which case the ATO would definitely cancel your credits.

So, that's the scheme part...
If it fails at this point, then whatever is written below may not be applicable. Although, I've been reading that the scheme criteria is almost automatically satisfied because it's so broad.

Relevant Circumstances:

I won't cover all of it, but this is where it conflicts a bit with the exemption. Thus, I am not sure which part takes precedent. (The following are not in order)

I don't know how they would argue that any shareholder would be in a better position than another unless you know in advance that the seller is a foreign-holder and how exactly are traders meant to know whose order's they are being filled against on the exchange.

Furthermore, the risk and duration of a stock being held is already negated with the small shareholder exemption that doesn't require the 45-day holding period rule. Or is it?

The rest of the criteria appears to be indifferent when analysing publicly traded equities. The dominant purpose may be challenged as the exchange is setup to trade interests in the shares rather than the dividends which are incidentally part of the shares, but depends on how the scheme is interpreted and what the scheme actually is.

This website gives a good summary for those who don't like looking at the actual legislation:
http://www.partiva.net/franking-credit-benefit

There is also some information about tax benefits and capital losses which could be cancelled...

It does appear to be interesting. I'm still wondering whether if there will be changes in the future seeing that there has been a push for budget surplus. If so, it will be interesting to see how exactly the rules would change.

Returning to the main point, I believe that the you can only be confident with the gain associated with the pre-dividend rally, if there is a gain to be captured. I suppose this was the original purpose of the thread as titled.

Significant risks include having to repay imputation credits and a nasty 10%+ ATO interest rate. Wasted brokerage and opportunity cost from the time spent seeking opportunities which were anticipated to exist but in actuality were not real.

I bet I would get a different answer each time I sought advice depending on their confidence in defending the position. x_X

Why am I interested?

As part of a free brokerage deal with westpac, I picked up some CBA shares at 66.80 on 15th February to capture an intra-day dip which closed at 67.03. On the 18th February CBA opens with 1.74 lower at 65.29 with a dividend of 1.64, but since I'm ahead I hold on and the rest is history. Exited the position later that day at 65.75, although it subsequently rose even higher.

I am now weighing up whether I can actually claim that franking credit or not... Or whether I can only access the capital gain.

I tried to do the same with Wesfarmers but was less successful, but now I have two different sets of franking credits that I am probably not able to access.
Note: I wouldn't have made a trade without free brokerage, but I'm not sure that matters.

 

[statisticalg]

If you are wondering, god this guy is an idiot, he created income.
He must now pay tax!

I'm actually in a zero-tax environment. This complicates it further.

Although, if I wasn't then shouldn't I still be able to access those credits, otherwise I would have made a poor trading decision.

Weird right?

 

[statisticalg]

Lost a large chunk of my portfolio today trying to dividend strip Woolworths...

Looks like I'll be claiming the franking credits afterall. I will be able to argue that there was significant risk undertaken.