Monday, June 10, 2013

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

Today, a new covered calls position was established in Dow Chemical Company (Ticker Symbol DOW) with a Jul2013 expiration and at the $33.00 strike price. The transactions are as follows:

06/10/2013 Bought 300 DOW shares @ $34.47
06/10/2013 Sold 3 DOW Jul2013 $33.00 Call Options @ $1.99
Note: the price of DOW was $34.65 today when these options were sold.
06/26/2013 Ex-dividend of $.32 per share

This covered calls investment is a strategic one that explicitly considers the upcoming quarterly dividend of $.32 with an ex-dividend date of June 26th. If the current time value (i.e. extrinsic value) of $.52 [$1.99 option premium - ($34.47 stock price - $$33.00 strike price)] remaining in the short call option decays to less than $.32 by June 25th (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:
If Early Assignment: +36.6% annualized return if the stock is assigned early (day prior to June 26th ex-div date); OR
If Dividend Capture: +20.4% annualized return if the stock is assigned at July 2013 expiration on July 20th

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 $33.00 strike price at assignment -- a nice 4.3% of downside protection.  Alternatively, if the stock declines below the strike price, the breakeven price of $32.48 ($33.47-$1.99) provides a substantial 5.8% downside protection from the original $33.47 purchase price. 

In summary, this covered calls investment provides a very nice annualized ROI potential for such a conservative (hedged with substantial downside protection and the next earnings announcement is after the July options expiration date) investment. 

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.   There are a very limited number of these "Early Assignment or Dividend Capture" covered call opportunites that meet the criteria below, but if/when we find them we should take full advantage.

As shown below, this DOW position satisfies almost all these criteria:

Two possible overall performance results (including commissions) for this Dow Chemical Company (DOW) covered calls position are as follows:
Stock Purchase Cost: $10,349.95
= ($34.47*300+$8.95 commission)

Net Profit:
(a) Options Income: +$585.80
= ($1.99*300 shares) - $11.20 commissions
(b) Dividend Income (If option exercised early on day prior to Jun 26th ex-div date): +$0.00
(b) Dividend Income (If stock assigned at Jul2013 expiration): +$96.00 = ($.32 dividend per share x 300 shares); or
(c) Capital Appreciation (If stock assigned early on June 25th): -$449.95
+($33.00-$34.47)*300 - $8.95 commissions; or
(c) Capital Appreciation (If stock assigned at $33.00 at Jul2013 expiration): -$449.95 +($33.00-$34.47)*300 - $8.95 commissions

Total Net Profit (If option exercised on day prior to Jun 26th ex-div date): +$135.85
= (+$585.80 +$0.00 -$449.95); or
Total Net Profit (If stock assigned at $33.00 at Jul2013 expiration): +$231.85
= (+$585.80 +$96.00 -$449.95)

1. Absolute Return (If option exercised on day prior to Jun 26th ex-div date): +1.6%
= +$135.85/$10,349.95
Annualized Return (If option exercised early): +36.6%
= (+$135.85/$10,349.95)*(365/16 days); OR

2. Absolute Return (If stock assigned at $33.00 at Jul2013 expiration): +2.2% = +$231.85/$10,349.95 Annualized Return (If stock assigned): +20.4%
= (+$231.85/$10,349.95)*(365/40 days);