Friday, September 13, 2013

Established Noble Corp Covered Calls -- Example of Early Assignment or Dividend Capture Strategy

Today, a new covered calls position was established in Noble Corp  (Ticker Symbol NE).  This NE position was established at the $38.00 strike price and with an Oct2013 expiration.

As detailed below, this investment will provide a +2.9% absolute return in 37 days (which is equivalent to a +28.4% annualized return) if the stock closes at or above $38.00 at options expiration on Oct 18th.  The current Greek value of Delta for this option of 60.0% provides a good estimate of the probability that the stock price will be above the $38.00 strike price at Oct2013 options expiration. Thus, the resulting expected value of the annualized ROI for this investment is +17.0% = (+28.4%x 60.0%).
This covered calls investment is a strategic one that explicitly considers the upcoming quarterly dividend of $.22 with an ex-dividend date of November 27th.  Although unlikely, if the current time value (i.e. extrinsic value) of $1.134 [$2.72 option premium - ($29.086 stock price - $27.50 strike price)] remaining in the short call option decays to less than $.22 by November 26th (the day prior to the ex-div date), then there is a 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: +3.8% absolute return (equivalent to +51.8% annualized return for the next 27 days) if the stock is assigned early (day prior to Nov 27th ex-div date); OR
If Dividend Capture:  +4.6% absolute return (equivalent to +32.2% annualized return over the next 52 days) if the stock is assigned at Dec 2013 expiration on December 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 is above the $27.50 strike price at assignment -- a nice 4.7% of downside protection.  Alternatively, if the stock declines below the strike price, the breakeven price of $26.146 ($29.086-$.22-$2.72) provides a very substantial 9.4% downside protection. 

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 December options expiration date) investment. 

Two possible overall performance results (including commissions) for this Agnico Eagle(AEM) covered calls position are as follows:
The details of the associated transactions and a potential return-on-investment result are as follows:

1. Noble Corp. (NE)
The transactions were as follows:
09/13/2013 Bought 300 NE shares @ $38.91
09/13/2013 Sold 3 NE Oct2013 $38.00 Call Options @ $2.10

A possible overall performance result (including commissions) for these Noble Corp covered calls is as follows:
Stock Purchase Cost: $11,681.95
= ($38.91*300+$8.95 commission)

Net Profit:
(a) Options Income: +$618.80
= 300*$2.10 - $11.20 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If NE assigned at $38.00) = -$281.95
= ($38.00-$38.91)*300 - $8.95 commissions

Total Net Profit (If NE assigned at $38.00): +$336.85
= (+$618.80 +$0.00 -$281.95)

Absolute Return if Assigned (at $38.00): +2.9%
= +$336.85/$11,681.95
Annualized Return If Assigned (ARIA): +28.4%
= (+$336.85/$11,681.95)*(365/37 days)

The downside 'breakeven price' at expiration is at $36.81 ($38.91 - $2.10), which is 5.4% below the current market price of $38.91.

The 'crossover price' at expiration is $40.10 ($38.00 + $2.10). This is the price above which it would have been more profitable to simply buy-and-hold Noble Corp until October 18th (the Oct2013 options expiration date) rather than establishing this covered calls position.