Friday, September 11, 2015

Established Covered Calls Position in Enterprise Products Partners LP

Today, a new covered calls position was established in Enterprise Products Partners LP (ticker symbol EPD).  Two hundred shares of EPD were purchased at $26.40 and two in-the-money Oct2015 Call options were simultaneously sold at the $25.00 strike price for $2.10 each.  This is the first Oct2015 position established in the Covered Calls Advisor Portfolio.  All other positions have Sep2015 expirations (i.e. one week from today).

EPD is the second largest company in the oil and gas midstream (Master Limited Partnerships) industry.  Along with most companies related to oil and gas, share prices in midstream companies have been crushed recently.  The Covered Calls Advisor believes that EPD is a bargain at the $25.00 strike price given the approximately 6.0% yield at that level and the near monopoly pipeline network of EPD in a substantial portion of its geography.

As shown below, this investment will provide a +2.3% absolute return in 36 days (which is equivalent to a +22.8% annualized return) if EPD stock closes above the $25.00 strike price on the October 16th options expiration date.

This potential return-on-investment result is attractive to us option sellers given this relatively conservative investment -- there is 5.3% downside protection (from the current $26.40 stock price to the $25.00 strike price).  The implied volatility in the options was approximately 39 when this position was established and there are no quarterly earnings or distributions prior to the October 16th options expiration date. 

The details of the associated transactions and a potential return-on-investment result are as follows:

1. Enterprise Products Partners LP (EPD)
The transactions were as follows:
09/11/2015 Bought 200 Enterprise Products Partners LP shares @ $26.40
09/11/2015 Sold 2 EPD Oct2015 $25.00 Call Options @ $2.10

A possible overall performance result (including commissions) for these Enterprise Products Partners LP covered calls is as follows:
Stock Purchase Cost: $5,288.95
= ($26.40*200+$8.95 commission)

Net Profit:
(a) Options Income: +$409.55
= 200*$2.10 - $10.45 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If EPD assigned at $25.00) = -$288.95
= ($25.00-$26.40)*200 - $8.95 commissions

Total Net Profit (If EPD assigned at $25.00): +$120.60
= (+$409.55 +$0.00 -$288.95)

Absolute Return if Assigned (at $25.00 strike price): +2.3%
= +$120.60/$5,288.95
Annualized Return If Assigned (ARIA): +22.8%
= (+$120.60/$5,288.95)*(365/36 days)

The downside 'breakeven price' at expiration is at $24.30 ($26.40 - $2.10), which is 8.0% below the current market price of $26.40.

Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing calculator, the resulting probability of making a profit (if held until Oct2015 options expiration) for this Enterprise Products Partners LP covered calls position is 68%. This compares with a probability of profit of 50.2% for a buy-and-hold of Enterprise Products Partners LP stock over the same time period. Using this probability of profit of 68%, the Expected Value annualized ROI of this investment (if held until expiration) is +15.5% (+22.8% * 68%).

The 'crossover price' at expiration is $28.50 ($26.40 + $2.10). This is the price above which it would have been more profitable to simply buy-and-hold EPD stock until October 16th (the Oct2015 options expiration date) rather than establish this covered calls position.