SKC Dividend pairs trading strategy

[craft]

I have done some quick research on applying this strategy for kids.

Basically it should work so long as there is no problem with designating it as business income. (I need to check this further)

Business income is not subject to the punitive income rates that relate to unearned income for minors. So the full tax free threshold plus low income rebate should be available. Also need to be designated as a business so that the trading losses aren’t quarantined as CGT losses whist dividend Income is assessable.

There doesn’t seem to be any restrictions on minors for the $5000 exemption for the 45 day rule.

Any tax accountants out there who can confirm this?

All we need now is to have the kids paper trade this earnings season and then find some mug to give them a non-recourse unsecured loan and they will be set for March/April.

Invoice for inspiration is in the mail.

They have promised to pay your invoice with their paper profits


One more question SKC. How much of the prices that you have been achieving are related to trade execution skill? If you were just hitting the open auction do you expect the strategy would still have an edge? That’s one of the things I want to determine this dividend season on paper before the kids mug coffs up. I suspect I’ll try and help them pick the pairs for a while and that will probably be their biggest handicap.

 

[skc]

All we need now is to have the kids paper trade this earnings season and then find some mug to give them a non-recourse unsecured loan and they will be set for March/April.

That mug sounds like you...

I am not sure this is a strategy for the kids. Although you can use your kid's name to do it if the ATO lets you.

One more question SKC. How much of the prices that you have been achieving are related to trade execution skill? If you were just hitting the open auction do you expect the strategy would still have an edge? That’s one of the things I want to determine this dividend season on paper before the kids mug coffs up. I suspect I’ll try and help them pick the pairs for a while and that will probably be their biggest handicap.

Not sure I can quantify that. Take IFL for example I exited on open at $6.22, 2 ticks below the day's high and it closed $6.04. On the other hand the IAG/SUN pair would have been much more profitable had I held to the close. So a bit hit and miss really.

I would say the key skill is to pick the pair/hedge rather than to achieve the optimal price. With IAG I could have picked anything from QBE, AMP, Big 4 or SUN. But SUN was a share that ran hard the day before for no apparent reason, so it's more likely to pull back (or at least not run) today.

They have promised to pay your invoice with their paper profits

That inspiration was on you. Don't make your kids pay for your inspiration!

 

[gunt]

This might be a beginner's question, but could you explain the short strategy a bit? Do you have any real expectation that the shorted stock will decrease, or is it simply a hedge in case the market takes a dive?

And is your exit based only on the desire to sell up after one day?

Cheers

 

[skc]

This might be a beginner's question, but could you explain the short strategy a bit? Do you have any real expectation that the shorted stock will decrease, or is it simply a hedge in case the market takes a dive?

And is your exit based only on the desire to sell up after one day?

Cheers

The short is more a hedge than something to profit from, but since you are short you want to pick a stock that looks like a good short candidate, using whatever market reading skill you care to deploy. For this strategy to work, you just want the short not go up too much.

The strategy is based around being able to strip the dividned and franking credit with as little risk as possible. Reduction in holding time is a good way to reduce your risks.

There is no stopping you holding on to either the long or short trade after you've successfully stripped the dividend. But that would simply be a directional trade in itself and not a dividend stripping pairs trade. I do this regularly. But I keep separate records. E.g. Say I am long APN from yesterday and I like the company and think it's undervalued. So when APN opened this morning at 84.5 it has done its job for this strategy and I record the P&L as if I sold at 84.5c. But in actual fact I kept the position open. I then make a separate record entry under say a bottom-picking strategy with an entry at 84.5c. That way I get to analyse my apples and oranges separately.

 

[skc]

Trade #9

Long 559 RHC @ $17.93. Dividend 29.5c 100% franked. Gross 42.1c (2.4%).
Short 872 SHL @ $11.47.

Trade closed

Sell RHC @ $17.69.
Cover SHL @ $11.39.

P&L = $139.3. Franking credits collected = $70.7.

P.S. RHC now up to $18...

 

[sammy84]

Long SWM short NWS?

SWM grossed up yield currently 10.3%

 

[skc]

Long SWM short NWS?

SWM grossed up yield currently 10.3%

SWM has run pretty hard but the yield is so big so the franking credits "should" hopefully offer enough protection.

 

[skc]

Trade #8

Long 2000 AHD @ $5.53. Dividend 27c. 100% franked. Gross = 38.6c (6.97%)
Short Index $3 x $4340.

Can't find a suitable hedge so an index will do for now.

Trade closed

Sell 2000 AHD @ $5.30.
Cover Index $3 @ $4230. (Trailing a stop on this but this is where I'll mark the trade).

P&L $624.1. Franking credits = $231.43.

Total closed 8 trades. P&L total $1769.2. FC = $1061.4.

 

[suhm]

I think this would make a decent strategy with a sufficient capital base to get to the 5k limit and if it could be done in multiple entities. Probably would work better in a sideways market as I think the competitive advantage of this strategy would be having an entity paying a lower tax rate such a super especially super in its pension phase or people without active income.

It doesn't suit my style though, I perfer to have a larger payoff even though the probability of success is lower.

It's a fair wait to get your franking credits back during this dividend season though.

 

[skc]

Long SWM short NWS?

SWM grossed up yield currently 10.3%

Trade #10

Long 2810 SWM @ $3.55. Div 26c, 100% franked. Gross = 37.1c (10.46%).
Short 629 NWS @ $15.91.

 

[village idiot]

liking the thread SKC, thanks.

just wondering how much dividend you 'pay' if you are short the cfd (in the same company you are long for the div), either through IB or thru a market maker like IG. Presumably they dont pay the grossed up amount when you are long across an xd date, so they wouldnt make you pay the grossed up amount if short (or maybe they do?)

if not, having the long inside super with the hedging short using a cfd in a fully taxed environment sounds a plan....

 

[skc]

I think this would make a decent strategy with a sufficient capital base to get to the 5k limit and if it could be done in multiple entities. Probably would work better in a sideways market as I think the competitive advantage of this strategy would be having an entity paying a lower tax rate such a super especially super in its pension phase or people without active income.

In 10 trades I am already up to ~$1,500 in franking credits. You can easily do this on 1 trade per day, which reduces your capital requirement to ~$25k.

The multiple entries thing is not a big deal as long as you stick to relatively liquid stock. With IB the broker is 8bps or $6 minimum, so you can do this with minimum position size of $7,500 and commission won't be a factor. So capital requirement can be further reduced, but will take more trades to get to $5K limit.

If you are sure we have a sideways market you might as well just long the ex-div share without hedge. The hedge is required because we are in a volatile market (has been for 3 years).

The tax status has no bearing on the competitive advantage of the strategy. $1 in franking credit is no different to $1 in other income. You pay tax on it at the same rate you would pay tax on any other income.

It doesn't suit my style though, I perfer to have a larger payoff even though the probability of success is lower.

I look at things on risk adjusted payoff... and this is pretty good if you consider $5k+ on $25k capital in 2 months. Note that the $5k is only the franking credit limit. There may be profits in addition to the franking credits collected. So far the total profits are 1.7x franking credits collected.

It's a fair wait to get your franking credits back during this dividend season though.

Yes that's why the Feb dividend season may be more suitable. There is also a wait on the dividend actually being paid but that's usually about a month as opposed to end of the tax year.

 

[skc]

liking the thread SKC, thanks.

just wondering how much dividend you 'pay' if you are short the cfd (in the same company you are long for the div), either through IB or thru a market maker like IG. Presumably they dont pay the grossed up amount when you are long across an xd date, so they wouldnt make you pay the grossed up amount if short (or maybe they do?)

if not, having the long inside super with the hedging short using a cfd in a fully taxed environment sounds a plan....

I've never been charged franking credits when I short an ex-div CFD. But I do seem to remember the prospectus saying that they can charge you if they want/have to. Best to confirm for yourself. Not sure about IB as I've never shorted during ex-div with them.

I don't know how franking credit limit / 45day rule works in the super environment so again check with your accountant. One potential issue is that your long positions will in most cases incur a capital loss on the trade. You want to make sure you have enough capital gains to offset the loss within super so you get the benefit of the loss in a timely manner.

 

[village idiot]

yes the 45 day rule would be a problem in super, as well as you cant be seen to do too much short term trading

but my main point was that you could use the cfd of the same share as the hedge, which would eliminate the tail risk (and the pairs correlation risk?). ? could be with another broker if you wanted to disguise what you are doing

 

[skc]

yes the 45 day rule would be a problem in super, as well as you cant be seen to do too much short term trading

but my main point was that you could use the cfd of the same share as the hedge, which would eliminate the tail risk (and the pairs correlation risk?). ? could be with another broker if you wanted to disguise what you are doing

This is in the PDS of MFGlobal. Not sure what "in some circumstances" mean, but probably means if you abuse it enough you will get caught out...

If a dividend or distribution is paid in respect of an underlying instrument or security while you hold a short position in a CFD in respect of the underlying instrument or security you must pay cash equal to the value of the dividend or distribution paid on such underlying instrument or security (if any) (plus, in some circumstances, the value of any franking credits applicable to that dividend or distribution)

But if it works, just do 1 trade a year and be done with it!

 

[skc]

Trade #10

Long 2810 SWM @ $3.55. Div 26c, 100% franked. Gross = 37.1c (10.46%).
Short 629 NWS @ $15.91.

Trade closed

Sell SWM @ $3.23.
Cover NWS @ $15.62.

P&L = $295.8. FC = $313.1

Trade #7

Long 500 MND @ $20.24. Dividend (ex Monday) 55c. 100% franked. Gross = 78.6c
Short 362 WOR @ $27.58.

Trade closed

Sell MND @ $19.1.
Cover WOR @ $26.3

P&L = $272.2. FC collected = $117.9.

TOTAL 10 trades P&L = $2337.2. FC collected = $1492.3.

 

[craft]

I have been doing some more thinking/research into utilising your pair’s dividend strategy.

Firstly the idea of getting the kids involved is legit, not just a tax dodge. The low risk of the strategy along with utilising the 45day exemption and the tax free threshold provides a potential beneficial back drop.

In thinking through the practicalities, I decided that the best hedge would be one index hedge of some sort to offset the market risk for the whole period. Doesn’t help with sector rotation but it doesn’t have the tail risk of a short being bought out either. The main consideration was the difficulty in picking the hedge. Reviewing a list of dividends due and a scanning the charts to find the ones heading NE is probably enough for the kids to deal with at this stage.

I think I have hit a major hurdle though. Because the actual trades will most likely be loss making there is no expectations of making a profit from trading and therefore it would be hard to argue that a trading business was being run. The dividend and franking credits would be deemed income from investing and assessable whilst the trading losses would be quarantined in the CGT regime. (also creating lots of paper work.) Additionally, because the income is not from business the kids would be hit with unearned income penalty tax. Oh well – onto the next idea.

Your strategy seems to have tax minimisation potential for some circumstances, Offsetting capital gains or for pre-existing trading businesses where the $5000 45 day exemption has not been exhausted.

Whilst I'm not preceding any further with this I am still interested in being a voyeur on this thread. One small request – could you tweak the updates to report separate Long P&L, Short P&L, Dividends Received & Franking credits

Thanks

 

[skc]

I have been doing some more thinking/research into utilising your pair’s dividend strategy.

Firstly the idea of getting the kids involved is legit, not just a tax dodge. The low risk of the strategy along with utilising the 45day exemption and the tax free threshold provides a potential beneficial back drop.

In thinking through the practicalities, I decided that the best hedge would be one index hedge of some sort to offset the market risk for the whole period. Doesn’t help with sector rotation but it doesn’t have the tail risk of a short being bought out either. The main consideration was the difficulty in picking the hedge. Reviewing a list of dividends due and a scanning the charts to find the ones heading NE is probably enough for the kids to deal with at this stage.

I think I have hit a major hurdle though. Because the actual trades will most likely be loss making there is no expectations of making a profit from trading and therefore it would be hard to argue that a trading business was being run. The dividend and franking credits would be deemed income from investing and assessable whilst the trading losses would be quarantined in the CGT regime. (also creating lots of paper work.) Additionally, because the income is not from business the kids would be hit with unearned income penalty tax. Oh well – onto the next idea.

Your strategy seems to have tax minimisation potential for some circumstances, Offsetting capital gains or for pre-existing trading businesses where the $5000 45 day exemption has not been exhausted.

I am surprised it took you that long to come up with this issue! There are plenty of easier ways to educate your kids about shares / trading.

The strategy is not about tax minimisation. It's about profiting. And the profit consist of dividends and franking credits offset against capital gains/losses. The 45-day rule and $5k threshold puts a limit on this strategy, because franking credit is a large part of the edge... but tax minimisation isn't the goal, nor is it achieved (I am paying more tax as a result of the profits!).

Whilst I'm not preceding any further with this I am still interested in being a voyeur on this thread. One small request – could you tweak the updates to report separate Long P&L, Short P&L, Dividends Received & Franking credits

Thanks

Should be pretty self explanatory...

As I said the hedge works much better when the market has a down day and the last 4 trades have demonstrated that.

 

[sammy84]

I personally like the strategy (if that isn't obvious so far). I have always tried during the div period to strip the div and franking credit, however, have never used a hedge. By using a hedge I am a lot more comfortable and there is an added opportunity to try and profit on the second leg (i.e the hedge). So thanks SKC.

Doesn't seem to be a lot on offer today though.

Thinking HIL and an index hedge.

 

[skc]

I personally like the strategy (if that isn't obvious so far). I have always tried during the div period to strip the div and franking credit, however, have never used a hedge. By using a hedge I am a lot more comfortable and there is an added opportunity to try and profit on the second leg (i.e the hedge). So thanks SKC.

Doesn't seem to be a lot on offer today though.

Thinking HIL and an index hedge.

Thanks Sammy glad you liked it. Keep in mind that if you go over the $5k franking credit limit you lose all franking credits that you didn't hold for 45 days.

I am actually not going to trade this strategy anymore for this dividend season. With other franking credits I've got I am already half way there, and we are only 2 months into the financial year... I might put up some mock trades however.

I think the chart of HIL is not too bad. And 5% gross is pretty decent. I havent' traded HIL for a while but I used to pair it up with other companies related to the buildings industry: BLD, CSR, HST, GWA, ALS, FBU etc...