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%.
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)
(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%
Annualized Return If Unchanged (ARIU): +63.8%
= (+$177.85/$5,654.95)*(365/18 days)
Absolute Return if Assigned at $19.00: +4.1%
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%.