Wednesday, April 4, 2012

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 Apr2012:
04/04/2012 Bought 300 MS @ $18.82
04/04/2012 Sold 3 MS Apr2012 $19.00 Calls @ $.66
Note: the price of MS was $18.87 today when the call options were sold.

Today, Morgan Stanley had declined by about 3.0% when this position was established.
This position is a repeat of a successful trade in Morgan Stanley for the March 2012 options expiration in which the stock ended in-the-money and the stock was called away. The implied volatility in the options sold had risen to 44.5 today, so the options premiums had increased to a very attractive level. The covered calls were established today at a level about 1% out-of-the-money.

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%.
Morgan Stanley Stock Chart

Morgan Stanley Stock Chart by YCharts

With Morgan Stanley's primary financial metrics now slowly improving, the stock's downside risk seems relatively small now relative to its upside potential.

A possible overall performance result(including commissions) for this Morgan Stanley position is as follows:
Stock Purchase Cost: $5,654.95
= ($18.82*300+$8.95 commission)

Net Profit:
(a) Options Income: +$186.80
= 300*$.66 - $11.20 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If MS price unchanged at $18.82): -$8.95
= ($18.82-$18.82)*300 - $8.95 commissions
(c) Capital Appreciation (If MS assigned at $19.00): +$45.05
= ($19.00-$18.82)*300 - $8.95 commissions

Total Net Profit(If MS price unchanged at $18.82): +$177.85
= (+$186.80 +$0.00 -$8.95)
Total Net Profit(If MS assigned at $19.00): +$231.85
= (+$186.80 +$0.00 +$45.05)

Absolute Return if Unchanged at $18.82: +3.1%
= +$177.85/$5,654.95
Annualized Return If Unchanged (ARIU): +63.8%
= (+$177.85/$5,654.95)*(365/18 days)

Absolute Return if Assigned at $19.00: +4.1%
= +$231.85/$5,654.95
Annualized Return If Assigned (ARIA): +83.1%
= (+$231.85/$5,654.95)*(365/18 days)

The downside 'breakeven price' at expiration is at $18.16 ($18.82 - $.66).
Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing calculator, the resulting probability of making a profit (if held until Apr2012 options expiration) for this Morgan Stanley covered calls position is 66.0%. This compares with a probability of profit of 51.7% for a buy-and-hold of MS over the same time period.

The 'crossover price' at expiration is $19.66 ($19.00 + $.66).
This is the price above which it would have been more profitable to simply buy-and-hold MS until April 20, 2012 (the Apr2012 options expiration date) rather than establishing the covered calls position. The probability of exceeding this crossover price at expiration is 34.2%.

1 comment:

  1. I've enjoyed following your blog and am following a similar strategy myself. This market is a roller-coaster ride, but by buying solid businesses and staying the course with covered calls, I definitely think you can out-perform market returns.