My First Option Trade

2016-06-01: Sold to Open 6 Contracts of Option F AUG 19 2016 13.00 C

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 own 600 shares of Ford Motor Company (NYSE:F) at an average cost basis of $12.94 per share. Ford pays quarterly dividends of 15¢ per share in the months of January, April, July and October. At the current price of $13.03, the stock yields 4.60%.

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