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Friday, October 19, 2007

Roll Ups Revisited – Fluor and Honeywell

For October expirations, two of eleven positions established in the Covered Calls Advisor Portfolio (CCAP) were rolled up from their initial strike price to a higher strike price. This article shows the trade history and the results to date for those two holdings, which were FLR and HON.

1. FLR – Closed

Since FLR was trading above the $150 strike price at the close on Friday 10/19, one call was exercised and the 100 shares of FLR were called away at the strike price of $150. The trading history, including the roll up transaction, was as follows:
9/18/07 Initial Stock Position -- BTO 100 FLR @ $138.17
9/18/07 Initial Call Option -- STO 1 FLR Oct 140 @$4.90
10/2/07 Roll Up Transaction -- BTC 1 FLR Oct 140 @ $11.60
10/2/07 Roll Up Transaction -- STO 1 FLR Oct 150 @ $4.50
10/20/07 Option Exercised – STC 100 FLR @ $150.00

The performance results (including commissions) are as follows:
Stock Purchase Cost: $13,826.95 ($138.17*100+$9.95 commissions)
Option Income: -$249.85 ($490-$1160+$450-$29.85 commissions)
Capital Appreciation: $1,163.10 [($150.00*100-$9.95)-$13,826.95]
Net Profit: $913.25 ($1,163.10-$249.85)

ANNUALIZED RETURN ON INVESTMENT:
(913.25/13,862.95)*(365/32 days) = 75.1%

Two important observations here:
(a) This result demonstrates the advantage of rolling up to a higher strike price when the underlying stock has increased substantially in price. When the initial covered call position was taken in FLR Initial FLR position,the maximum annualized return on investment was 55.6%. By transacting the mid-month roll up, the overall annualized ROI achieved increased by 19.5 percentage points from 55.6% to 75.1%. Remember: It is this advisor's strategy to consider roll ups only when there is a potential increase of at least 15 percentage points in the annualized ROI. Of course, the ability to achieve this higher return is dependent on the underlying stock’s ability to retain its price increase and to close at or above the higher strike price on the expiration date. In the 2nd example presented below with HON, an increased return was not achieved since the stock closed well below the higher strike price.
(b) This FLR example also demonstrates that covered call writing does not have to be, as it is frequently and erroneously portrayed, solely an income producing strategy. To take full advantage of the profit making potential of covered calls, both income and capital appreciation factors should be analyzed as to their respective potential contributions to the overall ROI performance in the covered call decision-making process.

2. HON – Interim Position

Like Fluor, the initial Oct’07 covered call position in Honeywell was rolled up to a higher strike price during the past month. Unlike FLR, HON did not close in-the-money but rather out-of-the-money. The trading history, including the roll up transaction, to date is as follows:
9/10/07 Initial Stock Position -- BTO 500 HON @ 54.23
9/10/07 Initial Call Option -- STO 5 HON Oct07 55 Calls @ 1.80
9/26/07 Roll Up Transaction -- BTC 5 HON Oct 55s @ $4.70
9/26/07 Roll Up Transaction -- STO 5 HON Oct 60s @ $1.10
10/20/07 Oct’07 Option Expiration Date – HON closed at $58.32

The performance results to date (including commissions) are as follows:
Stock Purchase Cost: $27,124.95 ($54.23*500+$9.95 commissions)
Option Income: -$929.85 ($180*5-$470*5+$110*5-$29.85 commissions)
Capital Appreciation: $2,035.05 ($58.32*500-$27,124.95)
Net Profit: $1,105.20 ($2,035.05 - $929.85)

ANNUALIZED RETURN ON INVESTMENT:
(1,105.20/27,124.95)*(365/40 days) = 37.2%

Although an excellent annualized ROI of 37.2% has been achieved to date, the analysis performed when the initial position was established Initial HON position demonstrates that a greater result would have been achieved if the roll up had not been transacted. In that case, the Oct 55 option would have been exercised, the stock called away, and the annualized ROI achieved would have been 43.2%. But again, 37.2% is still great and a decision will be made during the next 2 days concerning whether on Monday morning to sell the HON stock; or retain the HON stock and sell Nov’07 options against it. Regardless of the decision, an article will be posted on Monday after the transaction is completed.

Regards and Godspeed

1 comment:

  1. Good post, Jeff. Very timely. I did a similar rollup on a nov position a couple of weeks ago. Stock is below the new strike but could easily recover.

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