Options Update: August 2016

This article is the first in a new series of articles about my options trades in DivGro.

Some readers may not be interested in options, so they can just skip these articles. Others may be interested in learning about options or just following along. And I'm sure there are several dividend growth investors, who, like myself, are interested in boosting dividend income with options trades.

As for myself, this series will help me to track my options trades and to learn more about options. Certainly, some of the learning will come from research I do before writing articles, but I hope I'll also learn from questions and comments from those readers that share my interest in options trading.

To start, let me recap the trades I've executed and share a couple that I haven't reported yet.

My first covered call

I executed my first options trade for DivGro in July 2016, selling to open 6 contracts of $13 call options on Ford Motor Company (NYSE:F) with an expiration date of 19 August 2016. Here's the trade summary as reported:

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

Notice the format of the option symbol, which is underlined in the trade summary. I use the simpler option symbol format of my online brokerage firm Scottrade. First is the ticker of the underlying stock, in this case F. Then follows the expiration date and strike price ($13). Finally, the type of option is indicated by a C for calls or a P for puts.

The industry-wide standard option symbol format is one created by the Options Clearing Corporation (OCC), consisting of 21 characters in 4 parts:      1. Ticker of underlying stock or ETF, padded with spaces to 6 characters      2. Expiration date, 6 digits in the format yymmdd       3. Option type, either P or C, for put or call      4. Strike price, as the price x 1000 front padded with 0s to 8 digits. Here's an example for a fictional stock XYZ, courtesy of Scottrade: OCC Option Symbol: XYZ 100320C00027500 XYZ 10 03 20 C 00027 500   Symbol     (up to 6 chars)     Year     (2 chars)     Month     (2 chars)     Day     (2 chars)     Call/Put     (C or P)     Strike Dollar     (5 chars)     Strike Decimal     (3 chars)    Compared this with the simpler Scottrade format for the same fictional stock: Scottrade Symbol: XYZ MAR 20 2010 27.50 C XYZ       MAR       20       2010       27.50       C    Symbol       Month       Day       Year       Strike Price       Call/Put    I think the Scottrade format is easier to read.

Returning to my first options trade, let me explain the trade in simple terms.

I own 600 shares of Ford at an average cost basis of $12.94 per share. To boost dividend income, I sold 6 call options on my Ford shares and collected an option premium of 55¢ per share. The calls had a strike price of $13 and an expiration date of 19 August 2016.

By executing this trade, I agreed to sell my Ford shares for $13 per share on or before 19 August 2016. If Ford traded above $13 on 19 August 2016, the option buyer would have exercised the options to buy my Ford shares at a discount.

As it turns out, Ford closed at $12.39 per share last Friday. The options expired worthless (to the option buyer), so I got to keep the shares.

The option premium is mine to keep no matter what happened! As mentioned, I collected 55¢ per share. In comparison, Ford pays quarterly dividends of 15¢ per share. The trade lasted 80 days whereas one quarter lasts about 91 days.

If I could repeat a similar transaction 4 times a year, I would collect $2.20 per share in option premiums on top of 60¢ of dividend income. Currently, Ford yields 4.81%, but with the option premiums added it would be as if Ford yielded 22.94%. (Sometimes, Ford pays a special dividend on top of its regular quarterly dividends. I'm not accounting for those dividends here...)

A yield of nearly 23% is a significant boost of my dividend income!

It is not likely that I'll be able to repeat similar transactions 4 times a year. Option premiums depend on market volatility, which is rather low a the moment. Also, I did not account for commissions.

Nevertheless, lets say I could double the yield of my DivGro portfolio through options trading. That would make me very happy indeed! Right now, my DivGro portfolio has an average yield on cost (YoC) of 4.31% and projected annual dividend income (PADI) of $10,932. Doubling these figures would mean a YoC of 8.62% and PADI of $21,864.

Nice!

Of course, it will take a long time to ramp up to those figures, but that's what I'm hoping to do in the months and years to come.

To summarize, here are the details of my first options trade, this time accounting for commissions:

Open date	:	2016-06-01
Expiration date	:	2016-08-19		Number of days in trade	:	80
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 premium	:	$0.52582 per share		Net option income	:	$315.49
Instant option yield	:	4.06%		Annualized option yield	:	18.55%

I'm looking for an opportunity to enter another covered call trade on my Ford shares.

Another covered call

A few weeks ago, I entered another covered call trade, this time on shares of The Walt Disney Company (NYSE:DIS). Here's the trade summary:

2016-08-09: Sold to Open 1 Contract of Option DIS AUG 19 2016 98.50 C
Time to expiration on this trade was much shorter – only 11 days. On expiration day, DIS closed at $96.39 and the option expired worthless, allowing me to retain my shares:

Open date	:	2016-08-09
Expiration date	:	2016-08-19		Number of days in trade	:	11
Cost basis	:	$96.08 per share
Strike price	:	$98.50 per share
Number of contracts	:	1		Number of shares	:	100
Call premium	:	$0.95 per share		Option income	:	$ 95.00
				Brokerage commission	:	$   7.70
Net premium	:	$0.873 per share		Net option income	:	$ 87.30
Instant option yield	:	0.91%		Annualized option yield	:	30.17%

Though producing a smaller instant yield, this trade delivered a nice annualized yield of about 30%!

My first cash secured put

Another way to boost dividend income is to sell cash secured put options on stocks you wouldn't mind owning. What's great about this strategy is that you get to determine the price you're willing to pay! With many stocks trading at a premium to fair value, selling puts with a strike price that matches what you're willing to pay is a great way to get paid while waiting for the share price to drop.

Let's look at my first cash secured put trade to see how this strategy works:   2016-06-09: Sold to Open 1 Contract of Option TGT JAN 20 2017 65.00 P

I already own 40 shares of Target Corporation (NYSE:TGT) at a cost basis of $62.90 per share. Initial YoC is 2.73%. I would like to buy more shares of TGT but I prefer not to pay more than my original cost basis.

So here's where puts come in handy! I sold one put option on TGT and collected an option premium of $3.70 per share. The put has a strike price of $65 and an expiration date of 20 January 2017.

When I executed this trade, TGT was trading at $68.12 per share. That's higher than my original cost basis of $62.90 per share. By executing this trade, I'm agreeing to buy TGT shares for $65 per share on or before 20 January 2017. This is still higher than my cost basis, but not if we take the option premium into account – subtract $3.70 from the strike price of $65 and we get an effective price of $61.38 per share!

This trade is still open. At $70.81, TGT is trading well above the strike price. But there is still 5 months to go to expiration and anything can happen in that time. 

One possibility is that TGT continues to trade above the strike price. In this case the put option will expire worthless and I won't be obligated to buy 100 TGT shares for $65 per share. I'll get to keep the option premium of $3.70 per share. 

The other possibility is that TGT's share price drops below the strike price before expiration date. In this case, I'll likely be put the shares, meaning I'll be buying 100 shares for $65 per share. Note that I'll have to pay $65 per share even if TGT shares are trading for less than $65 at the time. However, my cost basis would be known – we've already worked it out at $61.38 per share.

Here's what the trade looks like in detail:

Open date	:	2016-06-09
Expiration date	:	2017-01-20		Number of days in trade	:	226
Strike price	:	$65.00 per share		Margin requirement (20%)	:	$1,300
Number of contracts	:	1		Number of shares	:	100
Put premium	:	$3.70 per share		Option income	:	$ 370.00
				Brokerage commission	:	$     8.25
Net premium	:	$3.6175 per share		Net option income	:	$ 361.75
Yield on margin	:	27.83%		Annualized yield on margin	:	44.97%
Stock price at execution	:	$68.12 per share		Stock price if exercised	:	$   61.38
Discount at strike price	:	4.58%		Discount with premium	:	9.89%

To sell put options, my online brokerage requires that I put aside some cash to secure the put. In a margin account, the amount is typically 20% of the purchase obligation. In a regular account, you'll be required to set aside 100% of the purchase obligation.

Notice that I'll either make about 28% on margin (if the option expires worthless), or I'll buy shares at an effective discount of about 10%.

Though somewhat riskier than covered calls, cash secured puts provide another cool way to boost dividend income!

Another cash secured put

I wrote about buying 300 shares of CSCO after 3 cash secured puts I sold got exercised. I won't repeat the details here, except to say that my effective buy price ($30.40) was a little below CSCO's closing price on expiration day ($30.52). That's not a huge discount, but, guess what? I'll take a discount of $36 anytime!

The bottom line is that I bought CSCO, a stock I wanted to own, at a discount of 9% to fair value. 

Preparing for more options trades

I've been closing some positions in my DivGro portfolio and raising cash to increase the number of shares of other positions. Since each option controls 100 shares, I need to own at least 100 shares of a stock to make it eligible for covered call trading. Here are the stocks in my DivGro portfolio that are available for options trading:

Ticker	Company	#Shares	Cost Basis	Recent Price	Call ADV	Put ADV
ABBV	AbbVie, Inc	100	$62.67	$64.72	1,965	653
CSCO	Cisco Systems, Inc	300	$30.40	$31.29	8,616	2,675
D	Dominion Resources, Inc	100	$72.90	$76.24	202	69
DIS	The Walt Disney Company	100	$97.56	$95.55	3,699	3,106
F	Ford Motor Company	600	$12.94	$12.47	8,590	4,103
GILD	Gilead Sciences, Inc	100	$94.49	$80.08	7,655	5,605
KMB	Kimberly-Clark Corporation	100	$118.88	$128.40	102	114
KO	The Coca-Cola Company	100	$40.60	$43.67	2,498	1,565
PFE	Pfizer Inc	100	$25.07	$34.77	3,133	1,770
RAI	Reynolds American, Inc	100	$29.03	$50.26	330	184

The last two columns show the average number of call and put options executed in 20 consecutive days, recently. I'm including it here to show how widely options trading volume varies by stock. 

The following stocks are potential candidates for options trading provided I round out the number of shares to 100 (or multiples of 100):

• Procter and Gamble (PG) – need to buy at least 68 more shares (cost ~ $5,977)
• Texas Instruments Inc (TXN) – need to buy at least 40 more shares (cost ~ $2,793)
• Union Pacific Corporation (UNP) – need to buy at least 44 more shares  (cost ~ $4,184)

Finally, I have stocks in my Folio Investing account that could be eligible for options trading, except that Folio Investing does not currently offer options trading. I'm considering transferring these stocks to Scottrade or, perhaps, Interactive Brokers, a brokerage that offers low options trading commissions.

• Apple Inc (AAPL) – own 100 shares
• The Gap, Inc (GPS) – own 165 shares 
• Intel Corporation (INTC) – own 120 shares
• Qualcomm Inc (QCOM) – own 100 shares 
• AT&T Inc (T) – own 150 shares

There are several other stocks in my Folio Investing account that I would need to round out to a share count of 100 shares (or multiples thereof). For the time being, though, I'll be quite busy working the opportunities that I do have right now. 

Options income tally

In these updates, I'll provide a running tally of the total amount received from options trades, as well as the options premiums secured due to options that expired.

#004	: 1	x	CSCO AUG 19 2016 31.00 P	::	$197.90	(total: $962.44 • secured: $402.79)
#003	: 1	x	DIS AUG 19 2016 98.50 C	::	$87.30	(total: $764.54 • secured: $402.79)
#002	: 1	x	TGT JAN 20 2017 65.00 P	::	$361.75	(total: $677.24 • secured: $315.49)
#001	: 6	x	F AUG 19 2016 13.00 C	::	$315.49	(total: $315.49 • secured: $315.49)

key: option income secured • trade still open • put option exercised

Thanks for reading! Please let me know if you found this article informative. Also let me know if you're interested in learning more about options, or just want to see how my goal of boosting dividend income with options income goes.