Hedged dividend capture : an examination of the HDC strategy on the Canadian derivatives market

Abstract

The paper presents research on the risk-reward profit potential when employing a hedged dividend capture (HDC) by means of a protective put strategy on dividend-yielding stocks traded on the Toronto Stock Exchange. By applying quoted mid-prices as an estimate of the price of the underlying stock and put-options applied to the hedge, the HDC strategy is hugely profitable throughout the sample period. However, when applying quoted bid/ask-prices as a proxy for transaction costs, the profitability of the strategy is erased, indicating that the market is efficiently priced. The success of the HDC strategy will therefore be determined by the level of transaction costs at which the investor is able to execute trades. Defining the relevant risk for an investor aiming to employ a HDC strategy has proven to be challenging. This paper applies performance measures implementing information from the higher moments of the return distribution, such as the Omega ratio, modified value-at-risk (MVaR) and modified Sharpe-ratio (MSR), and also analyzes the shape of the return distribution of the HDC strategy. It also demonstrates that, in terms of risk-reward, the HDC strategy outperforms the UHDC strategy over the sample period. Moreover, several first- and second-order Greeks are applied to measure the sensitivity of the put-options applied to the HDC strategy. It is shown by means of Delta, Gamma and DdeltaDvol that several options in the sample carry excess risk that potentially prevents the investor from being fully delta-hedged throughout the holding period of the HDC strategy.