One of my goals this year is to find opportunities to generate extra income by writing covered calls against DivGro positions in my Scottrade account.
Writing or selling covered calls is a safe way to earn extra income on top of the dividend income you already receive just for owning dividend paying stocks. You can sell one contract for every 100 shares you own and collect an option premium in return.
When selling covered calls involving dividend paying stocks, you hope to keep the shares in order to continue collecting dividends.
If the stock price remains below the option's strike price until the expiration date, the option expires and you retain your shares. You can repeat the exercise and generate more option income. As long as you retain your shares, you'll continue to collect dividends.
On the other hand, if the stock price moves above the strike price, the option holder will likely exercise the option and call away your shares. In that case, you'll be paid the option's strike price per share. Since you no longer own the shares, you'll forego future dividend payments.
Trade Details
I sold 6 call options on F at a strike price of $13.00 with an expiration date of 19 August 2016, collecting an option premium of 55¢ per share. The commission is annoyingly high at $14.51, so the effective option income is 52.58¢ per share.
Open date
| : | 2016-06-01 | ||||
Expiration date
| : | 2016-08-19 | Number of days in trade | : |
79
| |
Cost basis
| : | $12.94 per share | ||||
Strike price
| : | $13.00 per share | ||||
Number of contracts
| : | 6 | Number of shares | : | 600 | |
Call premium
| : | $0.55 per share |
Option income
| : |
$ 330.00
| |
Brokerage commission
| : | $14.51 |
Net option income
| : | $ 315.49 | |
Instant option yield
| : | 4.25% |
Annualized option yield
| : | 18.79% | |
Dividend before expiration
| : | $0.15 per share |
Dividend income
| : | $ 90.00 |
Here are the 3 possible scenarios:
1. Shares trade below strike price on expiration date
The options expire and I retain my shares. The option trade yields 4.25% over the trade period, or 18.79% annualized. I receive one quarterly dividend of $90 during the trade period, a yield of 4.64% on my cost basis. Total annualized yield is 23.43%. I can sell more calls on my shares and earn more option income.
2. Shares trade above strike price on expiration date
The options are exercised and my shares get called away. I make capital gains of 6¢ per share, or 0.46% on my cost basis. Adding the dividend and option premium, the total gain is 73.58¢ per share, or 5.69% on my cost basis over the trade period. That's 26.29% annualized. I forego future dividends unless I decide to buy shares again.
3. Shares trade above strike price before expiration and ex-dividend dates
The difference between this scenario and Scenario 3 is that the options get exercised before the ex-dividend date, which means I won't receive the dividend. Total gain is 58.58¢ per share, or 4.53% on my cost basis over the trade period. That's 20.93% annualized. The ex-dividend date has yet to be announced, but my guess is it will be near the end of July.
Scenario 1 is preferred, since I'll retain my shares and continue to collect dividends. Also, I could sell more call options on my shares and earn additional option income.
Scenarios 2 and 3 are acceptable, though not preferred. I'll have to pay short-term capital gains taxes.
I'll forego future dividends unless I decide to buy shares again. If the stock price jumps significantly, I won't share in the upside because gains are capped. Also, to get back in the game, I'll have to buy shares at a higher price. Of course, another covered call trade could soften the blow somewhat.
I'll be recording option income as a cash deposit transaction and keep a running tally of option income so generated. My focus with DivGro will continue to be generating a reliable and growing dividend income stream. I see option income as a way of boosting available cash so I can buy more dividend growth stocks.
Option income generated: $315.49
1. Shares trade below strike price on expiration date
The options expire and I retain my shares. The option trade yields 4.25% over the trade period, or 18.79% annualized. I receive one quarterly dividend of $90 during the trade period, a yield of 4.64% on my cost basis. Total annualized yield is 23.43%. I can sell more calls on my shares and earn more option income.
2. Shares trade above strike price on expiration date
The options are exercised and my shares get called away. I make capital gains of 6¢ per share, or 0.46% on my cost basis. Adding the dividend and option premium, the total gain is 73.58¢ per share, or 5.69% on my cost basis over the trade period. That's 26.29% annualized. I forego future dividends unless I decide to buy shares again.
3. Shares trade above strike price before expiration and ex-dividend dates
The difference between this scenario and Scenario 3 is that the options get exercised before the ex-dividend date, which means I won't receive the dividend. Total gain is 58.58¢ per share, or 4.53% on my cost basis over the trade period. That's 20.93% annualized. The ex-dividend date has yet to be announced, but my guess is it will be near the end of July.
Scenario 1 is preferred, since I'll retain my shares and continue to collect dividends. Also, I could sell more call options on my shares and earn additional option income.
Scenarios 2 and 3 are acceptable, though not preferred. I'll have to pay short-term capital gains taxes.
I'll forego future dividends unless I decide to buy shares again. If the stock price jumps significantly, I won't share in the upside because gains are capped. Also, to get back in the game, I'll have to buy shares at a higher price. Of course, another covered call trade could soften the blow somewhat.
I'll be recording option income as a cash deposit transaction and keep a running tally of option income so generated. My focus with DivGro will continue to be generating a reliable and growing dividend income stream. I see option income as a way of boosting available cash so I can buy more dividend growth stocks.
Option income generated: $315.49
Nice job Ferdi. I'm a big fan of selling covered calls. At six contracts, you were able to make a good chunk of money on this transaction. The best part is that Ford stock doesn't move much. So at the time of expiration, if the stock is over the strike price, you may want to just let it go then wait for a lower entry point. Or buy the contracts back, if the price is right.
ReplyDeleteHi Investment Hunting -- indeed, the premium income is almost (but not quite) what I would earn in dividends for a whole year. I'll see how the trade turns out. If the options are exercised I'll see if I can do another covered call that makes sense. Otherwise I'll just wait until the stock price drops again.
DeleteThanks for the detailed scenarios ,i would like to do this with some of the companies i own in my portfolio.
ReplyDeleteYou're welcome, desidividend -- I've been holding off for a long time but I'm now ready to boost my dividend income in this way.
DeleteGreat post as I'm still on the options sidelines. Would love to get my hand on covered calls or writing puts to potentially buy companies in my portfolio or simply keep the premium received. Appreciate the details of the trade and look forward to seeing how things pan out.
ReplyDeleteI think the idea of writing puts is interesting, especially to get into stocks at a preferred price level and earning income while you wait for that to happen. I'll keep my readers update on how this trade works out.
DeleteTake care!
I Love covered calls, but why did you choose a strike price so close to market price? If your preferred option is to hold the company, why not generate less in terms of the premium collected and do a $14 or $15 strike price? Sure, you'll collect less but you said your preferred goal is to keep the shares.
ReplyDeleteHi Evan -- I would have preferred a $14 but the available premium was just too low. As an example, right now with F trading at $13.18 the bid for the Aug 19 $13 call is 59¢ whereas the Aug 19 $14 goes for only 17¢. (The Aug 19 $15 call is "useless" at 4¢).
DeleteWhen I traded, the share price was at $12.98 or thereabouts, so I got slightly less and would have gotten even less than 17¢ for the Aug 19 $14 call.
Of course, I could go out further, but then the annualized yield drops correspondingly.
I tried to sketch the alternatives, i.e. if the options get exercised. Though I'd like to keep the shares, its not the end of the world if I have to give them up. I can turn around and immediately buy back the shares (possibly as a covered call!) even at a slightly higher cost basis and continue to collect dividends.
We'll see how it goes.
The bottom line is I collected 87.5% of the annual dividend ($315 versus $360) in about a quarter. Repeating that 4 times in a year is a heck of a boost.
Thanks for your comment and please keep in touch!
Hey there FerdiS, read the post a few times and my head hurts! I guess that is why I stick to just buying for long term.
ReplyDeleteStill, I am interested in Options--but I don't think this kind of an option. Seems to me you are looking to sell these shares? My question is similar to Evan's?
I would prefer to use the "Option" concept that allows me to buy a stock I really want at a lower price? I think it is called a "put" but I am not sure. Would love to see a comment on that.
Hi Mike A -- even though I named this post "My First Option Trade" its more correct to add "... for DivGro", since I've traded options many times in the past in other accounts.
DeleteCovered Calls (what I did here) is selling a CALL option on shares you own (you're covered). It is very save. You know upfront what the worst case scenario is.
Selling Puts (what you're suggesting) is a little less save, even though you know what you're potential commitment is upfront. Here's an example of why it is a little less save.
Say I want to buy 100 shares of F at $12 this year (its trading at $13.18 now). I can sell a Dec 16 $12 put for about 52¢ (x100 = $52). If F drops to below $12 before Dec 16, the buyer of the put will likely "put" the shares to me, so I'll have to buy them at $12 no matter how much it is trading below $12 at the time!
Let's say F screws up big time and the share price drops to $8 before Dec 16. I'll have to buy 100 the shares at $12, though, because I sold that option!
On the other hand, if F's share price drops to just below $12 and the option gets exercised, I'm still ahead! Why? Because I received 52¢ per share upfront in the form of an option premium, it would be as if I'm buying shares at $11.48 per share, not $12 per share.
The option buyer has the option, but not an obligation, to exercise the option. Depending on circumstances, the buyer does not have to "put" the shares to you. In either case, though, you get to keep the option premium.
Buying options (the opposite of what I'm doing) is WAY more risky. I won't be doing that in DivGro!
Great response FerdiS,
DeleteI would love to see a detailed post on the "put" option and why you don't like them on your blog. As mentioned, I avoid Options because I do not fully understand them. My comments illustrate that!
Still, for me ---the "price" of the stock never really matters after I have purchased it. I ALWAYS try to buy at a discounted price --So PRICE ALWAYS MATTERS--but only at buy time, once I am in---I am in.
I am not looking to sell generally. I am not looking for anyone to "call away" my shares. For me, the companies I buy are my retirement income source so its a weird concept for me to understand losing an "old faithful" due to a change in price, but no change in fundamentals or situation? I don't care about price, I care about dividend payment and increases in dividend payment.
How do Options square that?
Please read my response to Evan, also.
DeleteThe point with options is that you can boost your dividends (as I've done with this trade)!
I received 87.5% of my annual dividend for F in one trade. Repeating the same trade 3 more times means I can earn 3.5 times what F pays me annually. Let's say I'm not so efficient and I "only" get 3 times... that means, instead of collecting $360 per year in dividends from F, I collect $1,440. That's equivalent to a yield of about 18%!
It took me a long time to fully understand options. And I still consider myself a learner. I would advise anyone against trading options unless they understand what they're doing. For example, I don't do combo-trades (straddles, strangles, etc.) because I don't quite understand the nuances of those yet.