Friday, November 11, 2011

Roll Up and Out -- International Paper Co.

International Paper goes ex-dividend next Monday with a $.2625 dividend. Today, with the price of IP at $28.84 at about 3:30 this afternoon, the four Nov2011 $27.00 covered calls were well in-the-money. At that time, there was only $.02 of extrinsic value (i.e. time value) remaining in the Nov2011 $27 options with eight days remaining until options expiration. The Covered Calls Advisor thought there was a strong likelihood that the Nov2011 $27s would be exercised and the stock would be called away. A decision was made to retain the IP stock and to roll-up-and-out to the Dec2011 $28.00 strike price. The related transactions were:

11/11/2011 Buy-to-Close 4 Nov2011 $27.00 Calls at $1.86
11/11/2011 Sell-to-Open 4 Dec2011 $28.00 Calls at $1.80
Note: the price of IP was $28.84 when this credit spread was transacted.

The overall transactions history and a possible return-on-investment result are detailed below:

1. International Paper Co.(IP) -- Continuation Transaction
The transactions history is as follows:
09/19/2011 Bought 400 shares IP at $26.978
09/19/2011 Sold 4 IP Oct2011 $28 Calls @ $1.18
10/22/2011 Oct2011 options expired.
Note: the IP price was $25.93 at option expiration.
10/24/2011 Sold 4 IP Nov2011 $27.00 Call Options @ $.73
Note: the price of IP was $26.25 when the options were sold.
11/11/2011 Buy-to-Close 4 Nov2011 $27.00 Calls at $1.86
11/11/2011 Sell-to-Open 5 Dec2011 $28.00 Calls at $1.80
Note: the price of IP was $28.84 when this credit spread was transacted.
11/14/2011 Ex-Div $105.00 = $.2625 * 400 shares

Two possible overall performance results(including commissions) for this International Paper Co.(IP) transaction would be as follows:
Stock Purchase Cost: $10,800.15
= ($26.978*400+$8.95 commission)

Net Profit:
(a) Options Income: +$704.15
= (400*($1.18+$.73-$1.86+$1.80) - 3*$11.95 commissions)
(b) Dividend Income: +$105.00 = $.2625 * 400 shares
(c) Capital Appreciation (If stock assigned at $28.00): +$399.85
= ($28.00-$26.978)*400 - $8.95 commissions

Total Net Profit (If stock assigned at $28.00): +$1,209.00
= (+$704.15 +$105.00 +$399.85)

Absolute Return (If stock assigned at $28.00 at expiration): +11.2%
= +$1,209.00/$10,800.15
Annualized Return (If stock assigned at $28.00): +45.9%
= (+$1,209.00/$10,800.15)*(365/89 days)

This position demonstrates the triple-income potential of covered calls investing; by obtaining profit from all three potential profit sources available to covered calls investors, namely: (1) options income from selling calls; (2) dividend income; and (3) capital appreciation from an increase in the price of the underlying stock. Moreover, in this particular case, a total 11.2% absolute return could be achieved from this 3-month investment (a 45.9% annualized return-on-investment) -- a very attractive result for an investment in a company in the low-growth, mundane Paper and Packaging industry.

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