Monday, November 9, 2015

Covered Calls Position Established in Cummins Inc.

Today, a new covered calls position was established in Cummins Inc. (ticker symbol CMI) with a Nov2015 expiration.  The Cummins stock was purchased at $103.97 and the Nov2015 Call options were simultaneously (i.e. a single buy-write transaction) sold at the $102.00 strike price for $3.12 each.

This covered calls investment is a strategic one that explicitly considers the upcoming quarterly dividend with an ex-dividend date (Nov 18th) prior to the November 20th options expiration date.  Details of this position are provided below.

1. Cummins Inc. (CMI)
A $.975 quarterly dividend goes ex-dividend on November 18th.  If the current time value (i.e. extrinsic value) of $1.15 [$3.12 option premium - ($103.97 stock price - $102.00 strike price)] remaining in the short call options decay substantially by November 17th (the day prior to the ex-dividend date), then there is a possibility that the call option owner will exercise his/her option and will call the stock away to capture the dividend.  

As shown below, either early assignment or assignment at the Nov2015 options expiration date will provide very good return-on-investment results.

These two potential return-on-investment results are:
If Early Assignment: +1.0% absolute return (equivalent to +41.1% annualized return for the next 9 days) if the stock is assigned early (the business day prior to the Nov 18th ex-div date); OR
If Dividend Capture:  +1.9% absolute return (equivalent to +59.3% annualized return over the next 12 days) if the stock is assigned at Nov2015 expiration on November 20th.

11/09/2015 Bought 200 CMI shares @ $103.97
11/09/2015 Sold 2 CMI Nov2015 $102.00 Call options @ $3.12
11/18/2015 Upcoming ex-dividend of $.975 per share

Two possible overall performance results (including commissions) for this Cummins (CMI) covered calls position are as follows:
Stock Purchase Cost: $20,802.95
= ($103.97*200+$8.95 commission)

Net Profit:
(a) Options Income: +$613.55
= ($3.12*200 shares) - $10.45 commissions
(b) Dividend Income (If option exercised early on business day prior to Nov 18th ex-div date): +$0.00; or
(b) Dividend Income (If stock assigned at Nov2015 expiration): +$195.00
= ($.975 dividend per share x 200 shares)
(c) Capital Appreciation [If stock assigned early on Nov 17th (business day prior to November 18th ex-div date)]: -$402.95
+($102.00-$103.97)*200 - $8.95 commissions; or
(c) Capital Appreciation (If stock assigned at $102.00 at Nov2015 expiration): -$402.95
+($102.00-$103.97)*200 - $8.95 commissions

Total Net Profit (If option exercised on business day prior to ex-div date): +$210.60
= (+$613.55 +$0.00 -$402.95); or
Total Net Profit (If stock assigned at $102.00 at Nov2015 expiration): +$405.60
= (+$613.55 +$195.00 -$402.95)

1. Absolute Return (If option exercised on day prior to ex-div date): +1.0%
= +$210.60/$20,802.95
Annualized Return (If option exercised early): +41.1%
= (+$210.60/$20,802.95)*(365/9 days); OR

2. Absolute Return (If stock assigned at $102.00 at Nov2015 expiration): +1.9%
= +$405.60/$20,802.95
Annualized Return (If stock assigned): +59.3%
= (+$405.60/$20,802.95)*(365/12 days)

Either outcome would provide a very good return.  These returns will be achieved as long as the stock is above the $102.00 strike price.