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 Mar2012:
03/06/2012 Bought 500 MS @ $17.35
03/06/2012 Sold 5 MS Mar2012 $17.00 Calls @ $.76
Today, Morgan Stanley had declined by more than 5.0% when this position was established. The implied volatility in the options sold had risen to 46.9, so the options premiums had increased to a very attractive level. Because of the stock market's current spike in volatility, a somewhat conservative in-the-money position was established.
The 10-year chart below shows that Morgan Stanley is now trading at a historically low valuation relative to its book value. It is is now priced at about 50% of book value per share versus a historical norm above 100%.
With Morgan Stanley's primary financial metrics now slowly improving, the stock's downside risk seems relatively small compared with its estimated 50% upside potential for the next year ($26.00 target price).
A possible overall performance result(including commissions) for this Morgan Stanley position is as follows:
Stock Purchase Cost: $8,683.95
= ($17.35*500+$8.95 commission)
(a) Options Income: +$367.30
= 500*$.76 - $12.70 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If MS exercised at $17.00): -$183.95
= ($17.00-$17.35)*500 - $8.95 commissions
Total Net Profit(If MS exercised at $17.00): +$183.35
= (+$367.30 +$0.00 -$183.95)
Absolute Return if Assigned at $17.00: +2.1%
Annualized Return If Assigned (ARIA) +70.1%
= (+$183.35/$8,683.95)*(365/11 days)
The downside 'breakeven price' at expiration is at $16.59 ($17.35 - $.76).
Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing calculator, the resulting probability of making a profit (if held until Mar2012 options expiration) for this Morgan Stanley covered calls position is 71.9%. This compares with a probability of profit of 51.5% for a buy-and-hold of MS over the same time period.
The 'crossover price' at expiration is $17.76 ($17.00 + $.76).
This is the price above which it would have been more profitable to simply buy-and-hold MS until March 17, 2012 (the Mar2012 options expiration date) rather than establishing the covered calls position. The probability of exceeding this crossover price at expiration is 40.3%.