Saturday, January 31, 2015

A Commentary on Weekly Options -- January 30th Expiration Results

The Covered Calls Advisor Portfolio (CCAP) contained two positions (in Apple Inc. and Alibaba Group Holding ADR) with January 30th, 2015 expirations.  The Covered Covered Calls Advisor normally establishes monthly options positions, but these two positions were established in the very short-term weekly options.  The Chicago Board Options Exchange (CBOE) calls them 'weeklys', so although I prefer the spelling 'weeklies', I will comply with their preference.  Weeklys are a relatively recent creation, having begun in 2005.  They have continued to grow quickly to the point where there are now over 400 equity weeklys along with an additional approximately 60 ETF weeklys.  But another important requirement (at least for the Covered Calls Advisor) is that there is sufficient open interest  to obtain a reasonably narrow spread between the bid and ask prices in any specific option contract.  The Covered Calls Advisor will only consider selling an option when the bid-ask spread is no more than $.15, so this normally means that there is an existing open interest greater than 250 contracts.  Fortunately, there are now numerous weekly equity and ETF options that meet this threshold.

The decision to sell Weekly or Monthly options is a classic risk versus reward scenario.  When compared with Monthly options, Weeklys offer greater potential annualized return-on-investment possibilities, but can also result in greater annualized ROI losses.  This occurs because of the rate of time decay in the time value (aka extrinsic value) of options.  Note: time value is the dollar value of the option above parity.  The chart below shows that as an option gets closer to expiration, the daily rate of decay in time value increases and continues to increase daily until the date of expiration.     

The Covered Calls Advisor's two January 30, 2015 positions clearly demonstrates the dramatic risk-reward outcomes that can result from Weekly option positions.  Based on annualized return-on-investment results detailed below, the Apple Inc. position (+152.5%) was a great success whereas the Alibaba position (-67.7%) was a failure.  It should be noted that these results were more dramatic than would normally occur with Weeklys since there were quarterly earnings results issued by both Apple and Alibaba during the period when these two positions were held.  Apple had a blowout quarter resulting primarily from the huge sales of the iPhone 6 and 6 Plus and the stock surged higher; whereas in Alibaba's case, both the earnings report (revenues below analysts' expectations) along with China's SAIC report related to a problem with the amount of 'faked goods' on Alibaba's website resulted in a 10% fall in market value.  The increased uncertainty from an upcoming earnings report means increased implied volatility in the options premiums, thus larger return-on-investment outcomes (both positive and negative) than would be the case if there had been no earnings reports during the days when the positions were held.

1. Apple Inc. (AAPL) -- Closed
The transactions are as follows:
01/21/2015 Sold 2 Apple Inc. Jan 30, 2015 $112.00 Puts @ $5.20
Note: the price of AAPL was $108.50 when this transaction was executed
01/30/2015 Two AAPL Put options expired
Note: the price of AAPL stock was $117.16 upon options expiration yesterday

The Covered Calls Advisor does not use margin, so the return-on-investment information on this position and the result shown below reflect the fact that this position was established using 100% cash securitization for the two Put options sold.

The purchase cost (including commissions) for this transaction was as follows:
100% Cash-Secured Cost Basis: $22,400.00
= $112.00*200
Note:  the price of AAPL was $108.50 when these Put options were sold.

Net Profit:
(a) Options Income: +$1,029.55
= ($5.20*200 shares) - $10.45 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (AAPL closed above $112.00 strike price at Jan 30th, 2015 expiration): +$0.00
= ($112.00 liquidation price since options expired -$112.00 cash-secured cost basis)*200 shares

Total Net Profit (AAPL closed above $112.00 strike so the short options expired worthless): +$1,029.55
= +$1,029.55 options income +$0.00 dividend income +$0.00 capital appreciation

Absolute Return (AAPL closed above $112.00 strike price at Jan 30th, 2015 expiration): +4.6%
= +$1,029.55/$22,400.00
Annualized Return:  +152.5%
=  (+$1,029.55/$22,400.00)*(365/11 days)

2.  Alibaba Group Holding ADR (BABA) -- Closed
The transaction was as follows:
01/14/2015 Sold 1 Alibaba Group ADR Jan30th,2015 $95.00 Put option @ $3.00
Note: the price of BABA was $98.55 today when this transaction was executed.
01/30/2015 One BABA Put option assigned, so 100 shares of Alibaba purchased at $95.00 strike price
Note: the price of BABA was $89.08 upon options expiration yesterday

The purchase cost for this transaction was as follows:
100% Cash-Secured Cost Basis: $9,500.00
= $95.00*100

Net Profit:
(a) Options Income: +$292.30
= ($3.00*100 shares) - $9.70 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If BABA is above $95.00 strike price at Feb2015 expiration): -$592.00
= ($89.08 current market price -$95.00 purchase cost)*100 shares

Total Net Profit: -$299.70
= (+$292.30 +$0.00 -$592.00)

Absolute Return: -3.2%
= -$299.70/$9,500.00
Annualized Return (If BABA is above $95.00 at expiration): -67.7%
= (-$299.70/$9,500.00)*(365/17 days)