2023-09-21 22:00:10
In the stock market, one of the ways to obtain profitability from securities is to receive dividends. However, investors who are willing to take more risks can also resort to the so-called synthetic dividend.
It is obtained with a derivatives transaction and can help you make gains even when the share price falls. Before implementing this alternative, however, you need to be aware of how it works and the risks associated with it.
Next, you will discover what a synthetic dividend is and you will be able to understand everything regarding how it works!
What is a dividend and how does it work?
Starting with the common dividend, it is worth knowing that this is a type of dividend that is paid to shareholders of companies and shareholders of real estate funds. It consists of the result of dividing a percentage of the net profit obtained between investors.
This income makes up the profitability of the investment and can make it more attractive. Furthermore, it is usually paid periodically, as performance is assessed and as stipulated in the company’s statutes or fund rules.
Thus, dividends can be a way for the investor to obtain passive income, instead of just consolidating the performance of the investment with the sale of shares or quotas. It is also worth knowing that they are exempt from Income Tax.
What is synthetic dividend?
The synthetic dividend, in turn, is created in a different operation that is not related to the distribution of results by the share or the real estate fund. Instead, it is obtained by so-called covered writing of stock options from your portfolio.
As you will see, this dividend model is obtained in an operation that is considered a win-win operation. Through it, you can obtain a predictable return with a flow similar to that of a common dividend — hence the name.
How does this type of dividend work?
To understand this investment strategy, you must first understand the options market. They are derivatives, which means their value is linked to that of an asset.
In practice, stock options grant the right to buy or sell shares at a strike price on a certain date in the future. In this case, the person who buys the options is the taker and the person who sells them is called the writer.
To obtain the synthetic dividend, a covered entry of stock options must be made. Therefore, you are responsible for selling call options in relation to the shares that are already in your portfolio.
As it will not be necessary to purchase the assets to offer them to the option holder, the operation is said to be covered. Whoever purchases the option pays an amount called a premium.
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Operation results
From this negotiation, two main scenarios can happen. The first involves falling share prices.
In this case, exercising the option is not interesting, as the purchase price will be higher than the price exercised in the market. Thus, the taker will let the option expire and the writer will obtain as profit (or synthetic dividend) the premium that was paid.
The second scenario involves an increase in share prices on the stock exchange. The borrower will probably exercise the right to buy the shares more cheaply. As they are already in the caster’s portfolio, he will receive the prize plus the sale price of the shares.
In practice, it is possible to achieve positive results in both scenarios. In the second, the opportunity to make more profit is lost, because selling following an appreciation would help consolidate more profits. However, it is still a way to obtain gains from shares already in the portfolio.
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What are the advantages of synthetic dividend?
As you have seen, adopting the synthetic dividend strategy can be interesting to improve the profitability of shares in the short term. Since purchasing securities is usually a long-term investment, this is an alternative to obtaining a return in shorter periods of time.
It was also possible to see that it is a way to monetize shares that are sitting in the portfolio and that do not deliver as much performance. With this, the strategy can optimize your results in the stock portfolio.
Furthermore, the synthetic dividend can be an opportunity to protect yourself from market declines. By launching options before prices fall, you keep the shares in your portfolio and still earn the covered sale premium.
Due to its characteristics, the synthetic dividend is considered a type of share financing, as it allows the shares to be monetized in another way.
What are the risks involved?
It is necessary to remember that the operation known as synthetic dividend is linked to the derivatives market and, therefore, offers a greater risk. In addition to the characteristics of options, there is more volatility as it is a short-term operation, which increases the chances of losses.
Additionally, depending on how the transaction is executed, you may end the transaction without the shares in your portfolio. After all, there is an obligation to sell them if the borrower exercises the option. Therefore, consider the possibility of having losses in this regard.
However, it is possible to carry out risk management to consider the situations that may occur and the best way to mitigate them.
How can investment advice help?
To decide whether synthetic dividends are really the right alternative for you, it is worth having the support of investment advice. The experienced and certified team will be able to help you by answering any questions and presenting the characteristics and risks of this operation.
Furthermore, being able to access the knowledge of advisors will allow you to evaluate the adoption of other strategies in the stock market — and for your investment portfolio in general. This way, it will be possible to make more informed and consistent decisions.
Now that you know what a synthetic dividend is, this operation can be part of your investment strategy. However, as it involves more risks as it is done with derivatives, it is necessary to pay attention and correctly evaluate the characteristics before carrying it out.
If you want to count on the support of complete consultancy, please contact us at Renew Invest!
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