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Thursday, August 23, 2012

Established Dow Chemical Company Covered Calls -- Example of Early Assignment or Dividend Capture Strategy

Today, a new covered call position was established in Occidental Petroleum Corp. (Ticker Symbol OXY) with a Sep2012 expiration and at the $85.00 strike price. The transactions are as follows:

08/23/2012 Bought 200 OXY shares @ $87.80
08/23/2012 Sold 2 OXY Sep2012 $85.00 Call Options @ $3.95
09/06/2012 Ex-dividend of $.54 per share

This covered calls investment is a strategic one that explicitly considers the upcoming quarterly dividend of $.54 with an ex-dividend date of Sep 6th. If the current time value (i.e. extrinsic value) remaining in the short call option decays to less than $.54 by Sep 5th (the day prior to the ex-div date), then there is a reasonably good possibility that the call options owner will exercise early and will call the stock away to capture the dividend. As shown below, two potential returns for this position are:

+21.4% annualized return if the stock is assigned at Sep2012 expiration on Sep 21st
+31.3% annualized return if the stock is assigned early (day prior to Sep 6th ex-div date)

As is often the case, early assignment provides a higher annualized return, so this is the Covered Calls Advisor's preferred outcome; but either outcome would provide a very good return. These returns will be achieved as long as the stock stays above the $85.00 strike price at assignment -- a nice 3.2% of downside protection.

The Covered Calls Advisor has established a set of criteria to identify situations that are advantageous for establishing covered calls positions that might achieve good returns from either an early assignment or from assignment upon options expiration.  As shown below, this OXY position satisfies all these criteria:

Two possible overall performance results (including commissions) for this Occidental Petroleum Corp. (OXY) covered calls position are as follows:
Stock Purchase Cost: $17,568.95
= ($87.80*200+$8.95 commission)

Net Profit:
(a) Options Income: +$779.55
= ($3.95*200 shares) - $10.45 commissions
(b) Dividend Income (If stock assigned at Sep2012 expiration): +$108.00
= ($.54 dividend per share x 200 shares); or
b) Dividend Income (If option exercised early on day prior to Sep 6th ex-div date): +$0.00
(c) Capital Appreciation (If stock assigned at $85.00): -$568.95
+($85.00-$87.80)*200 - $8.95 commissions

Total Net Profit (If stock assigned at $85.00 at Sep2012 expiration): +$318.60
= (+$779.55 +$108.00 -$568.95); or
Total Net Profit (If option exercised on day prior to Sep 6th ex-div date): +$210.60
= (+$779.55 +$0.00 -$568.95)

1. Absolute Return (If stock assigned at $85.00 at Sep2012 expiration): +1.8% = +$318.60/$17,568.95
Annualized Return (If stock assigned): +21.4%
= (+$318.60/$17,568.95)*(365/31 days);
2. Absolute Return (If option exercised on day prior to Sep 6th ex-div date): +1.2%
= +$210.60/$17,568.95
Annualized Return (If option exercised early): +31.3%
= (+$210.60/$17,568.95)*(365/14 days)