Monday, January 30, 2012

Establish ProShares UltraShort 20+ Year Treasury Bonds ETF Covered Calls

A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of ProShares UltraShort 20+ Year Treasury ETF (Symbol TBT) covered calls as follows:

Established ProShares UltraShort 20+ Year Treasury ETF (TBT) Covered Calls for Feb2012:
01/30/2012 Bought 300 TBT @ $18.34
01/30/2012 Sold 3 TBT Feb2012 $19.00 Calls @ $.29
Note: the price of TBT was $18.34 when these call options were sold.

This investment corresponds to the Covered Calls Advisor's thesis that interest rates are bottoming. An out-of-the-money covered calls position in TBT will benefit if there is any increase in long-term Treasury Bond yields. Some readers might ask: "Why establish an out-of-the-money position in an inverse ETF instead of simply an in-the-money position in a direct investment (such as TLT)?"
My answer is: "An out-of-the-money position in the inverse TBT ETF enables the possibility of capital appreciation in the underlying ETF if interest rates are bottoming and begin to trend somewhat higher. This establishes the possibility of a substantially higher return-on-investment result compared with an in-the-money TLT position (since in-the-money covered calls positions eliminate the possibility of capital appreciation in the underlying equity).

Although there are unlimited outcomes, two possible overall performance results(including commissions) for this ProShares UltraShort 20+ Year Treasury ETF (TBT) position are as follows:
Stock Purchase Cost: $5,510.95
= ($18.34*300+$8.95 commission)

Net Profit:
(a) Options Income: +$75.80
= ($.29*300 shares) - $11.20 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If price of TBT is unchanged at $18.34): -$8.95
= ($18.34-$18.34)*300 - $8.95 commissions
(c) Capital Appreciation (If TBT above $19.00 at Feb2012 expiration): +$189.05
+($19.00-$18.34)*300 - $8.95 commissions

Total Net Profit(If TBT unchanged at $18.34): +$66.85
= (+$75.80 +$0.00 -$8.95)
Total Net Profit(If TBT above $19.00 at Feb2012 options expiration): +$264.85
= (+$75.80 +$0.00 +$189.05)

1. Absolute Return if Unchanged at $18.34: +1.2%
= +$66.85/$5,510.95
Annualized Return If Unchanged (ARIU): +23.3%
= (+$66.85/$5,510.95)*(365/19 days)

2. Absolute Return (If TBT above $19.00 at Feb2012 options expiration): +4.8%
= +$264.85/$5,510.95
Annualized Return (If TBT above $19.00 at expiration): +92.3%
= (+$264.85/$5,510.95)*(365/19 days)

The downside 'breakeven price' at expiration is at $18.05 ($18.34 - $.29).
Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing calculator, the resulting probability of making a profit (if held until Feb2012 options expiration) for this Hartford Financial Services Group Inc.(HIG) covered calls position is 60.8%. This compares with a probability of profit of 51.6% for a buy-and-hold of the Hartford over the same time period.

The 'crossover price' at expiration is $19.29 ($19.00 + $.29).
This is the price above which it would have been more profitable to simply buy-and-hold Hartford stock until Feb 17, 2012 (the Feb2012 options expiration date) rather than holding the covered calls position. The Options Pricing Model indicates that the probability that this will occur is 26.5%.