Think of it like powdered milk. Not exactly what you dream about when your grandma sends you a care package of cookies. But it works okay if the real stuff isn't around.
Dividends are cash payments companies make to stockholders. You own 100 shares of a firm that issues a quarterly dividend of $1 a share. Every three months, you get a check for $100. It's income generated just by holding a stock. Many stocks don't pay dividends. If a company believes it can create more value by reinvesting funds in it's business, it will keep the cash itself instead of sending checks to its shareholders. However, if you own these stocks, there are still ways to generate income from the shares. They aren't dividends, really. But, like dividends, they represent income you get from the shares you hold.
The most common way to create synthetic dividends is using covered call options. A call provides the holder the right, but not the obligation, to buy a stock at a certain price during a certain time frame. With this form of synthetic dividend, you sell this right to someone else. You receive a premium from the contract...income from your shares.
The potential downside comes if the person chooses to exercise their option. Now you have to sell the shares at the prearranged price, which might be below the current market price for the stock.
Related or Semi-related Video
Finance: What is Payment in Kind/PIK?44 Views
Finance allah shmoop what is payment in kind or a
pick All right so you know what a normal vanilla
dividend is right A company is so profitable it can't
think of anything else to do with its excess cash
so it just gives it back to its shareholders a
really nice gig if you can get it The company's
stock trading a twenty bucks a share pays twenty cents
a quarter in dividends or eighty cents a year and
well that yields four percent Got it that's eighty cents
over twenty bucks Simple vanilla dividend Will companies also often
carry debt The company whatever dot com has fifty million
dollars in debt which cost them six percent a year
or three million dollars a year to pay the interest
to rent that money when times were good the company
pays the interest in cash but dividends and interest payments
aren't necessarily always paid in cash They can be paid
in stock as well And yes this is weird Why
would a company pay a dividend or bond interest in
its own stock that would dilute the equity ownership of
the company So why would they do it Because they
had teo some companies will have offered bonds which give
the company the option of saying that interest either in
stock or in cash and company thinks it is in
jeopardy of potentially going bankrupt Well it will pay its
interest obligations in stock instead and this is generally a
very bad thing for equity holders and the bondholders I'm
so happy about it either because they don't know what
that stockton worth bond people are meeting potatoes kind of
people and they just like cats Thank you very much
So what does that communicate to the shareholders Well it
communicates that the company's management at least thinks it's equity
is overvalued so the company is choosing to dilute equity
holders by using its equity or stock as a currency
instead of cash and even worse the company might be
communicating well that it's cash obligations are so tight it
is so fearful of the b word that they have
to pay in stock or they might go bankrupt So
kind of armageddon ish scenario There cos will also pay
dividends in stock at times for largely the same reasons
but with different dilution dynamics Because in the case of
the equity owners of the company and people who own
their common shares all receiving you know pro ratted dividends
or equally the same number of incremental shares as dividend
meaning that the company is yes diluting itself but doing
so equally to basically everyone who is a common shareholder
So who does this screw in the process Option holders
Yeah employees usually like if they only own options they're
not entitled to dividends whether in cash or stock while
they get diluted away for there hard nonunion efforts Yeah
well this is called pick or payment in kind although
to those screwed over option holders there's a you know 00:02:55.183 --> [endTime] not much kind innit
Up Next
A derivative of a security is a "something" which derives its value based on the performance of that security... either a put option or a call option.
What's a dividend? At will, the board of directors can pay a dividend on common stock. Usually, that payout is some percentage less than 100 of ear...