Friday, June 3, 2011

Establish Morgan Stanley Covered Calls

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

Established Morgan Stanley (MS) Covered Calls for Jul2011:
06/03/2011 Bought 300 MS @ $22.988
06/03/2011 Sold 3 MS Jul2011 $25.00 Calls @ $.26
Note: the price of MS was $23.14 when the call options were sold.

Today, Morgan Stanley is trading at less than 80% of this year's expected tangible book value. The prior 10-year chart below shows that it is now priced at about 62% of book value per share versus a historical norm well above 100%.
Morgan Stanley Price Stock Chart

With Morgan Stanley's primary financial metrics now improving, the stock's downside risk seems minimal and its upside potential for the next year is estimated to be 50% above its current price ($34.50 target price).

Two possible overall performance results(including commissions) for the Morgan Stanley transactions would be as follows:
Stock Purchase Cost: $6,905.35
= ($22.988*300+$8.95 commission)

Net Profit:
(a) Options Income: +$66.80
= 300*$.26 - $11.20 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If MS unchanged at $22.988):
-$8.95 = ($22.988-$22.988)*300 - $8.95 commissions
(c) Capital Appreciation (If MS exercised at $25.00): +$594.65
= ($25.00-$22.988)*300 - $8.95 commissions

Total Net Profit(If MS unchanged at $22.988): +$57.85
= (+$66.80 +$0.00 -$8.95)
Total Net Profit(If MS exercised at $25.00): +$661.45
= (+$66.80 +$0.00 +$594.65)

Absolute Return if Unchanged at $22.988: +0.8%
= +$57.85/$6,905.35
Annualized Return If Unchanged (ARIU) +7.1%
= (+$57.85/$6,905.35)*(365/43 days)

Absolute Return if Assigned at $37.00: +9.6%
= +$661.45/$6,905.35
Annualized Return If Assigned (ARIA) +81.3%
= (+$661.45/$6,905.35)*(365/43 days)

The downside breakeven price at expiration is at $22.73 ($22.988 - $.26).
Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing calculator, the resulting probability of making a profit (if held until July2011 options expiration) for this Morgan Stanley (MS) covered calls position is 56.3%. This compares with a probability of profit of 51.3% for a buy-and-hold of Morgan Stanley (MS) over the same time period.

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