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In Finance, a Dividend Future is an Exchange-traded derivative contract that allows investors to take positions on future dividend payments. Dividend Futures can be on a single company , a basket of companies or on an Equity index . They settle on the amount of dividend paid by the company, the basket of companies or the index during the period of the contract. Example: If company A pays a quarterly dividend of 0,25$ per quarter in 2012. If an investor buys a 2012 Dividend Future, the Settlement Price of the Future will be equal to 4 x 0,25$ = 1$ per contract. The profit or loss the investor will make would depend on the difference between the price the investor bought or sold the Dividend Future and the Settlement Price. For instance, if the investor bought the 2012 Dividend Future at 0,90$, he would make a profit of 0,10$ per contract.

Most of the Dividend Futures trades occur before the dividend is known, hence allowing investors to go "long" or "short" the future dividend payment. The "buyer" of the contract, is said to be "long", and the "seller" of the contract, is said to be "short". The terminology reflects the expectations of the parties - the buyer hopes or expects that the dividend is going to increase, while the seller hopes or expects that it will decrease. Note that the contract itself costs nothing to enter; the buy/sell terminology is a linguistic convenience reflecting the position each party is taking (long or short).

Dividend Futures are usually traded in increments/lots/batches of 100 or 1000 and have a 1 year time span. When purchased, no transmission of share rights or dividends occurs. Being futures contracts they are traded on margin, thus offering leverage, and they are not subject to taxes equity holders are subject to when they receive dividend distribution on their stock(s). They are traded in various financial markets, mainly in Europe and Asia, and several Blue chip companies and Equity Indices are available with maturities going as long as 5 years for Equities and 10 years for Equity indices.

History

Before Dividend Futures existed, an investor who wanted to get a similar exposure was doing it by trading a Dividend swap. Dividend Swaps are the over-the-counter version of Dividend Futures. They allow two parties to agree to swap in the future a pre-defined amount of cash against the amount of dividends paid by the underlying stock, basket or equity index. Created in the early 2000s, Dividend Swaps became very popular because they allowed equity holders to "sell" their future dividends in advance and hence hedge they future dividend stream. The biggest players were investment banks looking to cover their future dividend exposure from derivatives positions they had on their book. The first Dividend Future was listed in June 2008 by Eurex, one of the worlds leading derivatives exchanges, on the Euro Stoxx 50 dividends and since a lot of new Dividend Futures were created on various exchanges and Underlyings.

The listing made these products available to wider range of investors who could not trade Over-The-Counter, and gave these products the exposure and interest to bring it to its full potential. Yet there are many developments to come in this emerging product, since the underlying (dividends) is widely known and distributed by companies around the world.

A new asset class

From a hedging instrument, Dividend Futures have the potential of developing as an asset class on their own. From an investor perspective, Dividend Futures give exposure to specific cash flow stream from a company. Unlike equities, where an investor is exposed to an infinite dividend stream, Dividend Futures allow investors to choose the year they want to get exposed on. From a risk profile perspective, dividends are also quite unique. When a company's profit improve, dividends usually rise and when they fall dividends are cut. However, dividends are a bit more resilient because companies tend to smooth the variations of their dividend payments. For these reasons, dividends are in between stocks and bonds in terms of risk-reward. Because they're simple, easy to understand and give a unique risk-reward for investors, Dividend Futures saw a tremendous growth since their first listing in 2008 and are still expanding.

References

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