CME Group's Dividend Index futures provide a transparent view on future implied dividend distributions along the curve with some maturities going out 10 years.

It is important to highlight the supply and demand aspects of dividend risk. The main supply of dividends comes from structured products and bank derivative books. When there is heavy supply, bank traders hedge the risk often at a discount to create further capacity to facilitate more business within their risk limits. Hence, the discount. Take the example of the trading activity in the S&P 500 Annual Dividend Index Dec 2020 futures during the Covid-19 pandemic. In March 2020, the futures fell sharply as uncertainty surmounted over potential dividend cuts.

The implied dividend market as expressed via the dividend index futures, repriced this risk and subsequently traded at a discount. Whilst a few dividends in the underlying stocks were omitted, over time the market expectations of dividend payouts normalized and the futures began to rise in April 2020. Thus, while dividends may have looked cheap, they were subject to pricing volatility. In this example, dividend futures provided the market the ability to either hedge out the risk prior to the risk event occurring, or for investors who believed the stress of the situation resulted in a mispricing, the opportunity to take advantage of the implied discounted dividends and benefit from the volatility and pricing adjustment once the market normalized.

Meta took the market by surprise that it would pay its first-ever quarterly dividend of USD 0.50 to investors since Facebook floated on the stock market in 2012. ^[1] This was announced on its earnings as of February 1, 2024, after the market closed.

• As Meta is an index component of both the S&P 500 and Nasdaq-100, the inclusion of the dividend would impact the pricing of their respective dividend Index futures associated with them.
• Meta’s announced quarterly dividend went ex-div as of February 21, 2024, indicating a quarterly dividend cycle in: February, May, August and November.
• While other companies announced dividend increases such as Chevron, Gilead Sciences and 3M, all their dividends were in line with forecasts.

S&P 500 Dividend Annual Index futures - Meta’s quarterly dividend equates to around 0.53 DIPs on an annual basis, representing 0.74% of the S&P 500 Annual Dividend Index Dec 24 futures (71.65) as of February 1, 2024.

Nasdaq-100 Dividend Annual Index futures - Similarly, Meta’s dividend would equate to 3.65 DIPs on an annual basis, representing 2.48% of the Nasdaq-100 Annual Dividend Index Dec 24 futures (147.0) as of February 1, 2024.

Exhibit 2 depicts the term structure for the S&P 500 Quarterly Dividend Index futures for various dates. The market in general had not priced in a Meta dividend – both from the Dividend Index futures on an implied basis and from bottom-up estimates from analysts. Post announcement, the futures witnessed between 0.19 – 0.24 DIPs increase shift across the term structure based on the 1 day change on the settlement price, on February 1, 2024, with the futures prices rallying between 1.0% –1.3% across the curve with an increase in open interest of around 2% in the Dec 24 contract.

Exhibits 3a and 3b depict the term structure for the S&P 500 Annual Dividend Index futures and Nasdaq-100 Annual Dividend Index futures, again both reflecting dividend uncertainty. The S&P 500 Annual Dividend Index futures saw a DIPs variance of between 0.4 – 1.3 shift across the term structure over the same period, with the futures rallying between 1.0% – 1.3% across the curve. While the Nasdaq-100 Annual Dividend Index futures reflected more dividend uncertainty, seeing between 2.5 – 8.0 DIPs increase over the term.

^{Source: CME Group, * S&P Global Market Intelligence Dividend Forecasting, in terms of dividend index points}

Exhibit 4 details the premium/discount of the dividend index futures relative to bottom-up estimates before Meta’s dividend announcement and post.

As of February 1, before the announcement of Meta’s dividend, the S&P 500 Annual Dividend Index futures were trading at a discount between -3.0 and -14.8% relative to bottom-up estimates. As of February 2, this discount had narrowed slightly to between -2.6 and -13.9%.

Similarly bottom-up estimates for Nasdaq-100 dividends, the futures discount varied between -1.5% to -13.7% and as of February 1 and this changed to between -1.3 and -12.6% the day after.

The rationale behind the difference in the magnitude between the two indices could be that the Nasdaq-100 has a higher percentage of stocks not paying dividends relative to the S&P 500 and that the market is assimilating the possibility of more stocks paying dividends.

Whilst other technology stocks could look to initiate dividends, typically their 10K’s will often point to share repurchasing as replacements for dividends, potentially limiting dividend upside.

This discount can provide interesting trading opportunities depending on supply and demand dynamics. Implied dividends can trade differently depending on their maturity. Whilst bottom-up forecasts are a key driver of value for near term implied dividends i.e., up to two-year maturities, for the longer dated implied dividends they typically trade more as a function of yield. As such, the longer dated implied dividends tend to be highly correlated with index spot levels to maintain a relatively stable dividend yield. The issuance of structured products also impacts the valuations for longer-dated maturities.

Currently, S&P 500 Dividend Index futures are expecting the growth in dividend payouts over the next decade to be lackluster. What they imply about the equities market being overvalued tends to reinforce concerns of the potential for exceptional market volatility ahead. Some of the gloomy outlook could be due to corporate earnings being near record highs as a percentage of the economy, making it difficult for further significant gains.

Summarizing the longer-term trends for dividends and broadly speaking:

• The equity payout story is structural and pivoted on corporate earnings.
• Driven by tax policies.
• Incentives for companies have been to buy back stock rather than returning capital to shareholders.

When dividend uncertainty exists, investors can seek dividend-based opportunities.

1. Investors looking to capture the difference between implied and realized dividends can take directional views on dividends which are over-valued (sell) or under-valued (buy).
2. Calendar spreads – Investors can combine the buying and selling of dividends index contracts in different maturities and can also take views on future dividend spreads between different years. Implied dividends can trade differently depending on their maturity.
3. Relative value trading across indices. For example, if investors believe that there could be further upside in the technology against other sectors, trading the Nasdaq-100 Annual Dividend Index against S&P 500 Annual Dividend Index futures.
4. As markets have evolved, the increased liquidity of dividend index futures has given investors the opportunity to access dividend exposure efficiently, irrespective of the price movement of the underlying benchmark index.

Key features of futures include, but are not limited to:

Liquid granular execution strategies

• Liquidity of the S&P 500 Annual Dividend Index futures in 2023: daily liquidity of USD 61M and open interest notional of USD 3.6B (notional).
• Transparently manage positions – Flexible execution, including block trades and liquid screen trading capabilities offer multiple ways to manage liquidity risk.
• Taking a Short Position – For futures, entering a short position is operationally equivalent to entering a long position.

Trading with expiries along the curve

• Range of futures expiries which allow investors to fine tune their exposure:    
  • S&P 500 Quarterly Dividend Index futures – first five months in March quarterly cycle.
  • S&P 500 Annual Dividend Index futures – Nearest 11 December.
  • Nasdaq-100 Annual Dividend Index futures – December annual contracts listed for six consecutive years.
  • Russell 2000 Annual Dividend Index futures – December annual contracts listed for six consecutive years.

Capital efficiencies and margin offsets

• Optimize capital deployment –S&P 500 Annual Dividend Index futures are currently 2-3% and subject to change
• Margin offsets – Traders may qualify for margin offsets with other CME Group contracts including offsets specific to the underlying Equity Index futures.

• CME Group Equity Dividend Index futures and options are important tools portfolio managers use to maximize capital efficiencies, minimize portfolio risks and execute both long and short positions.
• CME Group Equity Dividend Index futures can help investors seek dividend trading based opportunities and express their views either as directional, or calendar spreads or as a relative value strategy or even isolating dividend exposure.
• Dividend Index futures allow for trading, transferring and hedging of dividend risk exposure that is standardized, exchange listed and offers a transparent listed block and screen alternative to the OTC market.

Source: CME Group

Quarterly and annual contracts are available on the S&P 500 Index, allowing greater flexibility and fine-tuned dividend exposure. Annual contracts are available on the Nasdaq-100 and Russell 2000 Indices.

^{[1] https://www.ft.com/content/fabb6df0-5652-44af-a40a-4783b43fd016}