The definition of synthetic dividend’
Type of incoming cash flow that an investor creates with certain financial securities to receive dividend-like payments flow that resembles the periodic cash receipts from a dividend stock .
Breaking down the ‘synthetic dividend’
Investors create synthetic dividends in cases where assets such as shares and ETFs generally do not pay dividends. This strategy is reminiscent of dividends, but investors should keep in mind that there is more risk involved, because parameters are used, and the share price growth may be limited.
Created as a synthetic dividend
For example, suppose that an investor owns shares in the company that does not pay a quarterly dividend. In order to create cash flow from stocks, the investor could write covered Call options on the underlying asset. By doing so, the investor will receive the premium as incoming cash flow, but will be required to sell the shares to the option buyer that the person will choose to implement the options.
Owners of shares have the right to sell their shares at any time at market price. The covered call option is simply selling that right to someone else in exchange for cash today. This means that you are giving the option buyer the right to buy your shares before the expiration of the option at a predetermined price, called the strike price.
A call option is a contract which gives the buyer of the option the right (but not the obligation) to buy 100 shares of the underlying asset at the strike price any time before the expiration date. If the option seller owns the stock option is considered “covered” because of the ability to deliver the shares without purchasing them on the open market in an unknown and possibly higher future prices.
This situation, limiting the price growth potential, an investor can realize from his or her own shares, creates dividends as cash flow. Keep in mind that if you want to sell your shares before the expiration of the call, you should buy an option which will cost you extra money and part of the profits.
For this strategy, many investors look for stocks of solid stable companies that for one reason or another not to pay dividends. A vivid example of Warren Buffett’s berkshire hathaway V. Buffett doesn’t believe in dividend payments, but with this strategy, the investor can move his or her own way.