Friday, October 23, 2009

Establish ITT Corporation Covered Calls

A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of ITT Corporation (ITT) covered calls as follows:

Established ITT Corporation (ITT) Covered Calls for Nov09:
10/23/09 Bought 300 ITT @ $55.28
10/23/09 Sold 3 ITT Nov09 $55.00 Calls @ $2.60
The option premium was especially attractive with an implied volatility (IV) of 40. This premium is larger than would normally be the case with a fairly large and predictable company such as ITT, but pending earnings on October 30th cause the IV to inflate above normal levels, which can be beneficial for covered calls investors who are sellers of call options.

This position represents a covered calls "ex-dividend early exercise strategy". ITT will go ex-dividend on Nov 10th with a quarterly dividend payment of $.213. So for this position, analysis of the potential returns for two scenarios is made: (1) an early exercise; or (2) a later exercise at the Nov09 expiration date. It is likely that the owner of the long calls will exercise early on the day prior to the ex-dividend date (November 9th in this case) only if the $.213 dividend amount is greater than the time value remaining in the call option at that time. It should be noted that for this covered calls position, a potential exercise under either scenario provides a good return-on-investment result, although an early exercise provides a substantially higher annualized return (+87.5% versus +56.1% -- see below for details). Therefore, an early exercise is the Covered Calls Advisor's preferred outcome, but either of these exercise outcomes would provide excellent returns for the Covered Calls Advisor Portfolio.

ITT Corporation (ITT) is primarily a producer of defense electronics and fluid technology products. Fluid technology products (33% of sales) include pumps, valves, heat exchangers, mixers and fluid measuring instruments and controls for residential, agricultural, commercial, municipal and industrial applications. Defense electronics and services (54% of sales) are sold to the military and to government agencies. Products include traffic control systems, jamming devices that guard military planes against radar guided missiles, digital combat radios, night vision devices, radar, satellite instruments and other. Motion & flow control products (14% of sales) include switches and valves for industrial and aerospace applications, products for the marine and leisure markets, and fluid handling materials such as tubing systems and connectors for various automotive and industrial markets for the transportation industry.
In July 2009, the company raised its guidance for 2009 earnings per share to a $3.50 to $3.70 range from estimated revenues between $10.8 and $11.0 billion.

The 'Buy Alerts' spreadsheet below shows that ITT has a 'Total Points' rating of 20.83 which exceeds the Covered Calls Advisor's desired threshold of 20.0 points. As such, ITT became a viable candidate as a potential covered calls investment.


























Note: For expanded view, left click on the spreadsheet above.

Some potential results from this transaction are:

1. If Stock Exercised Early
It is likely that the owner of the long calls will exercise early on the day prior to the ex-dividend date if the ITT $.213 dividend amount is greater than the time value remaining in the call option at that time. Since the time value today when this position was established was substantial at $2.32 [$2.60-($55.28-$55.00)], early exercise would be likely to occur only if there is a substantial compression (from $2.32 to below $.213) in the time value on the day prior to ex-dividend (i.e. November 9th). The likelihood of this occurence is relatively low and would only happen if there is a bullish move in the ITT stock price during the next 17 calendar days between today and November 9th. If this does occur and the option owner decides to exercise their call options early on 11/9, then the overall performance results(including commissions) for the ITT transactions would be as follows:

Stock Purchase Cost: $16,592.95
($55.28*300+$8.95 commission)

Net Profit:
(a) Options Income: +$768.80 (300*$2.60 - $11.20 commissions)
(b) Dividend Income: +$0.00
(c) Capital Appreciation: -$92.95
= ($55.00-$55.28)*300 - $8.95 commissions

Total Net Profit: +$675.85
= (+$768.80 +$0.00 -$92.95)

Absolute Return if Exercised Early on 11/09/09 = +4.1%
= +$675.85/$16,592.95

Annualized Return if Exercised Early on 11/09/09 : +87.5%
= (+$675.85/$16,592.95)*(365/17 days)


2. If Stock Exercised at Nov09 Expiration
It is likely that the owner of the long calls will not exercise early, on the day prior to the ex-dividend date, if the $.213 dividend amount is less than the time value remaining in the call option at that time. In this case, the overall performance results(including commissions) for the ITT transactions upon Nov09 expiration would be as follows:

Stock Purchase Cost: $16,592.95
($55.28*300+$8.95 commission)

Net Profit:
(a) Options Income: +$768.80 (300*$2.60 - $11.20 commissions)
(b) Dividend Income: +$63.90 ($.213 * 300 shares)
(c) Capital Appreciation: -$92.95
= ($55.00-$55.28)*300 - $8.95 commissions

Total Net Profit: +$739.75
= (+$768.80 +$63.90 -$92.95)Net Profit:

Absolute Return if Exercised upon Nov09 Expiration on 11/21/09: +4.5%
= +$739.75/$16,592.95

Annualized Return if Exercised upon Nov09 Expiration on 11/21/09: +56.1%
= (+$739.75/$16,592.95)*(365/29 days)

Downside Breakeven Price Point: $52.467
= $55.28 - $2.60 - $.213
Downside Breakeven Protection: 4.5%
This in-the-money position provides up to 0.5% [($55.28-$50.00)/$55.28] downside protection available while still achieving the maximum potential annualized return-on-investment of +56.1% from this covered calls position.

If you have questions or comments about this "ex-dividend early exercise strategy" or anything related to this post, please feel free to submit them -- they are always welcomed. Click the 'comments' link below or post them on the justcoveredcalls Yahoo!Group site. If you prefer confidential communications, my email address is listed at the top-right sidebar of this blog site.

1 comment:

  1. Hey Jeff,
    this looks like a good trade. I do hope you get called early. Earnings would make me nervous, though.

    Jeff W

    ReplyDelete