SYNTHETIC DIVIDEND

Today's word: SYNTHETIC DIVIDEND
Theme for this fortnight: DIVIDENDS

A type of incoming cash flow that an investor creates with certain financial securities to produce a dividend-like payment stream that resembles the periodic cash receipts from a dividend-paying stock.

For example, suppose an investor owns shares in a company that does not pay a quarterly dividend. In order to create a cash-flow stream from the shares, the investor could write covered call options on the underlying stock. By doing so, he or she would receive the option premiums as an incoming cash flow, but would be obligated to sell the shares to the option-buyer should that person choose to exercise the options.

This situation, while limiting the potential price appreciation the investor can realize from his or her own shares, creates a dividend-like cash flow stream.