When big boys go ex-dividend, cum dividends cum out to play

YOU might be aware that Commonwealth Bank and Telstra, two of the biggest income stocks in the market, went ex-dividend last Monday. You might also be interested to know that on that day $3.5 billion of CBA and Telstra traded, which was 40 per cent of the total market trade.

Talk to a full-service stockbroker operator and they will tell you that they spent all of Monday and Tuesday switching from TLS into TLSCD (the cum-dividend quote), switching from CBA into CBACD (the cum-dividend quote) and selling CBA ordinary stock and switching into all the other major banks that have dividends coming up in May.

A lot of retail investors have no idea what a cum-dividend quote is and what all the fuss was about. Here's an explanation for all you income and franking hungry zero-tax-status investors out there.

Temporary cum-dividend markets (when requested by a broker) are established in some stocks by the ASX for two days only after a big, popular income stock goes ex-dividend; that is, the day the stock goes ex dividend and the following day.

These cum-dividend markets have been around for years and were basically designed to solve an issue that arose in the options market when buyers of call options were exercised before a stock went ex-dividend but couldn't deliver because the stock they held had already gone ex-dividend the day after they were exercised. In other words, option holders were getting caught out having to deliver cum-dividend stock, but only had ex-dividend stock to deliver.

So the cum-dividend quotes were established to allow them to go into the market and buy cum-dividend stock to deliver. They also came to be used by call option writers to avoid crystallising tax issues on the sale of existing holdings by allowing them to buy and deliver cum-dividend stock.

The use of these essentially options market-focused cum-dividend quotes have since been noticed by retail and institutional investors and are now actively used by tax-free superannuation funds in particular as a means to double-dip on dividends and franking.

The way it works is that when a major bank or income stock (like Telstra or CBA this week) goes ex-dividend, franking-focused investors, usually investors in a zero-tax environment, sell stock that just went ex-dividend and (often simultaneously) instruct their broker to buy the same amount of stock cum-dividend through, in this case, the TLSCD or CBACD quotes.

If the difference between the price achieved for the ex-dividend stock and the price paid for the cum-dividend stock is less than the dividend plus the franking, less costs, then you're quids in.

The general intention is to get an additional dividend and the net franking credit benefit for less than you pay. Usually you can.

But you can only do it during the two-day period after a stock goes ex-dividend, you can only do it where the relevant security (primarily big dividend-paying options traded stocks) has had a cum-dividend market established on the ASX, and you can only do it when there are enough sellers willing to sell shares that include the entitlement to the imputation credit to other parties. And by the way, you don't have to switch, you can just buy cum-dividend stock outright.

Of course, there are several other issues, such as compliance with the 45-day rule (on both the holding you sell and the holding you buy), liquidity and execution issues, the funding costs of the position that need to be offset, the delay in

getting the franking from the Tax Office, your eligibility for the franking, the possibility of the law changing your tax status before the strategy completes and your dealing costs.

If any of that interested you, don't email me - this is not advice, it is a heads-up. Take it up with your friendly neighbourhood full-service broker - they will be only too happy to help.