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Tuesday, October 23, 2012

Established iShares MSCI Emerging Markets ETF Covered Calls

Today, a new covered calls position was established in iShares MSCI Emerging Markets ETF (ticker symbol EEM) with a Nov2012 expiration and at the $41.00 strike price. The transactions are as follows:
10/23/2012 Bought 700 EEM shares @ $41.10
10/23/2012 Sold 7 EEM Nov2012 $41.00 Call Options @ $.98
Note: the price of EEM shares was $41.14 today when these options were sold.

A possible overall performance result (including commissions) for this iShares MSCI Emerging Markets ETF (EEM) covered calls position is as follows:
Stock Purchase Cost: $28,778.95
= ($41.10*700+$8.95 commission)

Net Profit:
(a) Options Income: +$671.80
= ($.98 X 700 shares) - $14.20 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If EEM assigned at $41.00 upon expiration): -$78.95
=+($41.00-$41.10)*700 - $8.95 commissions

Total Net Profit (If EEM assigned at $41.00 at Nov2012 expiration): +$592.85
= (+$671.80 +$0.00 -$78.95)

Absolute Return (If EEM assigned at $41.00 at Nov2012 expiration): +2.1%
= +$592.85/$28,778.95
Annualized Return (If stock assigned): +28.9%
= (+$592.85/$28,778.95)*(365/26 days)

The downside 'breakeven price' at expiration is at $40.12 ($41.10 - $.98).  Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing calculator, the resulting probability of making a profit (if held 26 days until Nov2012 options expiration) for this iShares MSCI Emerging Markets ETF covered calls position is 66.5%. This compares with a probability of profit of 50.2% for a buy-and-hold of EEM over the same time period.

The 'crossover price' at expiration is $41.98 ($41.00 + $.98).  This is the price above which it would have been more profitable to simply buy-and-hold EEM stock until November 16, 2012 (the Nov2012 options expiration date) rather than establishing the covered calls position. The probability of exceeding this crossover price at expiration is 35.8%.

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