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Friday, September 25, 2009

Establish EMCOR Group Inc. Covered Calls


A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of EMCOR Group Inc (EME) covered calls as follows:

Established EMCOR Group Inc(EME) Covered Calls for Sep09:
09/25/09 Bought 300 EME @ $24.91
09/25/09 Sold 3 EME Oct09 $25.00 Calls @ $.95

You might recall that covered calls positions were held in EME for both Aug09 and Sep09 expirations and in both cases the positions ended in-the-money and the stock was called away. The strong fundamentals and value-oriented conditions that existed when these previous positions were established remain intact; so it was decided today to re-establish a covered calls position in EME with an Oct09 expiration.

EMCOR Group, Inc. is an Engineering and Construction (E&C) company that provides electrical and mechanical construction and facilities services worldwide. It engages in the design, integration, installation, start-up, operation, and maintenance of various electrical and mechanical systems; heating, ventilation, air conditioning, and refrigeration; fire protection systems; plumbing systems; and various industrial maintenance services. Maintaining a corporate reputation for quality is essential for success in the highly-competitive bidding processes that is commonplace in the E&C industry. EMCOR is preeminent in this regard. In Fortune's Most Admired Companies rankings, EMCOR is #1 in the E&C category; and Forbes rates EMCOR as the "Best Managed" company in the Construction Industry.

Some potential results from this transaction are:
Absolute Return if Stock Price Unchanged at $24.91: +3.8%
Annualized Return If Unchanged (ARIU): +63.2%

Absolute Return if Exercised at $25.00: +4.2%
Annualized Return If Exercised (ARIE): +69.3%

Downside Breakeven Price Point: $23.96
Downside Breakeven Protection: 3.8%

7 comments:

  1. Do you ever consider selling the puts instead of doing a Buy/Write, in this case selling the October 50 puts?

    ReplyDelete
  2. Tom,
    I'm assuming you meant the EME Oct09 $25 puts?
    I would only consider selling cash-secured puts (CSPs) if the implied volatility (IV) of the puts was higher than the IV of the comparable call options, so that the potential ROI would be greater for selling the puts than for the covered calls (CCs). As you know, however, this is rarely the case since the IV for comparable puts and calls are normally very close to each other. In this circumstance, CCs and CSPs are synthetically equivalent for the same strike price and expiration month.
    In a prior post, I discussed some subtle differences between CCs and selling CSPs. You will see that, at least for me, the preponderance of the factors tended to favor covered calls overall:
    http://tinyurl.com/q95sso
    Regards,
    Jeff

    ReplyDelete
  3. Jeff,

    I started writing covered calls last August, right before the crash (lucky me!). My question to you is I did a search of your blog for the words "stop loss" and I did not get any results. Do you use stop losses?

    My problem was the stocks I held continued down, and even though I rolled as much as possible, there was no way to keep up, and I would have been much better off getting stopped out. In the end the whole experience was not profitable, and I changed my strategy to protecting my positions with a married put. But I established this change in Feb 2009 when volatility was extreme, and paid dearly for the puts. And I spent the next 6 months basically funneling my covered call income into paying for the decay in the puts.

    So bottom line, how have you done through the downturn? I was really really gung ho on the whole CC thing, made my own calculator and tracker to follow rolls and positions amounts, etc. but I have lost faith. I've had three situations in particular that have dampened my spirit for CCs:

    1) Down market. Without a stop or other protection, the loss in the underlying can wipe out months of income instantly.
    2) Up market. The $300-2000 I would make on the call writes were far overshadowed by the multi-thousand gains in the underlying. I rolled, sure, but then what usually ended up happening is the stock then retraced and I ended up with income that did not cover the loss.
    3) Protection against the downside with married puts ended up eating away too much of the premium.

    Thanks, and hope things are going well!

    ReplyDelete
  4. Mike,
    Enjoyed reading your very perceptive comments.
    1. I agree 100% that buying protective puts is simply too costly. More of my thinking on this topic is shown in #2 in this post: http://tinyurl.com/9vc3fa
    2. I never use stop losses. I admit I haven't studied this question fully, but several investors I admire advise against their use, primarily on the basis of being stopped out by a gap-down fill by a market maker. Moreover, since I monitor my portfolio daily, I find stop loss settings largely unnecessary.
    3. I hope you haven't truly "lost faith" in covered calls. One consolation during a bear market (such as 2008) comes if we measure our results against an overal buy-and-hold benchmark (such as the S&P 500 or Russell 3000). Although my portfolio lost 20.5% in 2008, encouragement nevertheless comes from the fact that we beat the market since the Russell 3000 benchmark was down 38.4% last year. So we cannot expect to make a positive return every year with covered calls, but it is conceivable, and my intention to show via this blog over a prolonged period of time, that beating the overall market averages is achievable through covered calls investing.

    Best Wishes and
    Stick with Covered Calls,
    Jeff

    ReplyDelete
  5. Jeff,

    Thanks! You are correct, I was down significantly less than if I was strictly buy and hold. I just have felt that if I coupled that with a stop loss protection, I would have been even better off; actually by my calculations, I would have been positive for the year. I need to explore a One Triggers Other type of setup, where if the underlying drops to a stop loss, it triggers the buyback of the option and sale of the stock.

    My biggest concern going forward, if I were to restart CC writing, the next few months, in my estimation, are going to be overall down months and I do not envy the decisions you'll need to make about rolling down or cutting losses. I am nearly 100% in cash right now, with just a couple small positions.

    Regards,

    Mike

    ReplyDelete
  6. Mike,

    With your low risk tolerance, my best suggestion for you is to take Warren Buffett's "Best Advice" and
    "take the emotion out of investing and simply stick with good businesses.":
    http://tinyurl.com/mjc65u
    Purchasing "good businesses" and perhaps selling next-month one-strike in-the-money call options (i.e. covered calls) against your holdings would likely be a good investment method for you to consider. Some stalwart companies to consider (by sector)in this regard would include:
    Consumer -- KO,PG,WMT
    Energy -- XOM,SLB
    Financials -- JPM,GS
    Healthcare -- ABT
    Industrials -- XLI
    Info Tech -- IBM,MSFT
    Telecom -- T or VZ
    International -- EEM,EFA

    Regards and Best Wishes,
    Jeff

    ReplyDelete
  7. Jeff & Mike,

    I think all of these were interesting points. I would completely agree with Jeff on the topic of stop-losses as they tend to create more problems then they solve, and will sometimes make you less involved in your portfolio as you should be. One example I can give, was that two years ago I owned Apple stock, put a 10% stop loss on it while I was on vacation, came back and the trade had been executed, but the stock had simply bottomed right on my stop-loss and then started marching higher. Many times, the large market-makers will push a stock down, if there are a large number of stop-losses at one particular price.

    In terms of covering downside risk, one possible recommendation I have would be to executed put spreads (i.e. sell a higher strike put, and buy a lower strike put), it will slightly lower your profitability but can greatly protect against huge losses. Also, keep in mind, if there is a dividend payment during the month of the option, that dividend will be inherent in the put price.

    ReplyDelete