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Tuesday, December 1, 2015

Established Two New Positions

Today, positions were established in iShares China Large-Cap ETF (ticker symbol FXI) and Cal-Maine Foods Inc. (CALM).  FXI is a covered calls position with a Jan2016 expiration that explicitly considers the potential for capturing the upcoming semi-annual ex-distribution expected on Dec 18th.  For Cal-Maine, Dec2015 100% cash-secured Put options were sold (in lieu of a comparable covered calls position) since the implied volatility of the Puts exceeded that of the Calls (thus providing a higher potential return-on-investment result).  Given the Covered Calls Advisor's current Slightly Bearish overall market outlook, conservative investments were made for both positions (with the strike prices below the stock prices when the positions were established).

As detailed below, the potential returns are:
1. iShares China Large-Cap ETF: +2.3% absolute return in 46 days (equivalent to a +18.1% annualized return-on-investment)
2. Cal-Maine Foods Inc.: +2.3% absolute return in 18 days (equivalent to a +47.6% annualized return-on-investment)

Note: the Implied Volatility (IV) of the options at the time they were sold was 25 for iShares China Large-Cap ETF and 43 for Cal-Maine Foods Inc., so each option exceeded the Covered Calls Advisor's minimum threshold of IV>20 and thus provides a sufficiently attractive potential return-on-investment relative to the conservative risk profile of each position.  

1. iShares China Large-Cap ETF (FXI) -- New Covered Call Position
A semi-annual distribution is expected on December 18th.  The amount of the distribution has not yet been declared, but a best estimate of $.50 is included in the potential results analysis below.  Although very unlikely, if the current time value (i.e. extrinsic value) of $.42 [$2.02 option premium - ($37.60 stock price - $36.00 strike price)] remaining in the short call option decays substantially below the approximately $.50 distribution amount by December 17th (the business day prior to the ex-distribution date), then there is a possibility (although unlikely) that the call option owner would exercise early and call FXI away to capture the distribution.

As shown below, two potential return-on-investment results for this position are:
If Early Assignment: +1.0% absolute return (equivalent to +20.5% annualized return for the next 17 days) if the stock is assigned early (business day prior to Dec 18 ex date); OR
If Dividend Capture: +2.3% absolute return (equivalent to +18.1% annualized return over the next 46 days) if the stock is assigned at Jan2016 expiration on January 15th.

The transactions were:
12/01/2015 Bought 300 FXI shares @ $37.60
12/01/2015 Sold 3 FXI Jan2016 $36.00 Call options @ $2.02
Note: a simultaneous buy/write transaction was executed.
12/18/2015 Upcoming semi-annual distribution estimated at $.50 per share

Two possible overall performance results (including commissions) for this FXI covered calls position are as follows:
Stock Purchase Cost: $11,287.95
= ($37.60*300+$7.95 commission)

Net Profit:
(a) Options Income: +$595.80
= ($2.02*300 shares) - $10.20 commissions
(b) Distribution Income (If option exercised early on business day prior to Dec 18th ex-distribution date): +$0.00; or
(b) Distribution Income (If FXI assigned at Jan2016 expiration): +$150.00
= ($.50 dividend per share x 300 shares)
(c) Capital Appreciation (If FXI assigned early on Dec 17th): -$487.95
+($36.00-$37.60)*300 - $7.95 commissions; or
(c) Capital Appreciation (If FXI assigned at $36.00 at Jan2016 expiration): -$487.95
+($36.00-$37.60)*300 - $7.95 commissions

Total Net Profit (If option exercised on day prior to Dec 18 ex-distribution date): +$107.85
= (+$595.80 +$0.00 -$487.95); or
Total Net Profit (If FXI assigned at $36.00 at Jan2016 expiration): +$257.85
= (+$595.80 +$150.00 -$487.95)

1. Absolute Return [If option exercised on Dec 17th (business day prior to ex-distribution date)]: +1.0%
= +$107.85/$11,287.95
Annualized Return (If option exercised early): +20.5%
= (+$107.85/$11,287.95)*(365/17 days); OR

2. Absolute Return (If FXI assigned at $36.00 at Jan2016 expiration): +2.3%
= +$257.85/$11,287.95
Annualized Return: +18.1%
= (+$257.85/$11,287.95)*(365/46 days)

In this instance, early assignment provides a slightly annualized return, so this is the Covered Calls Advisor's preferred outcome; but either outcome would provide an attractive return-on-investment result for this investment.  These returns will be achieved as long as the stock is above the $36.00 strike price at assignment.  If the stock declines below the strike price, the breakeven price of $35.58 ($37.60 -$2.02) provides a substantial 5.4% downside protection below today's purchase price.

2. Cal-Maine Foods Inc. (CALM) -- New 100% Cash-Secured Puts Position
The transaction was as follows:
12/01/2015  Sold 4 CALM Dec2015 $50.00 100% cash-secured Put options @ $1.20
Note: the price of CALM was $52.10 today when this transaction was executed.

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

This morning there was some aggressive selling of Cal-Maine stock in reaction (this advisor believes it is an over-reaction) to some BB&T commentary about pricing softness in the current quarter for shell eggs (Cal-Maine is the leading U.S. producer).   The Covered Calls Advisor has been analyzing Cal-Maine for several weeks and decided to use today's price weakness accompanied by an increase in CALM's implied volatility to 43 for the Dec2015 $50.00 Puts as an opportunity to enter this position in Cal-Maine. 

A possible overall performance result (including commissions) would be as follows:
100% Cash-Secured Cost Basis: $20,000.00
= $50.00*400
Note: the price of Cal-Maine was $52.10 when these options were sold

Net Profit:
(a) Options Income: +$469.05
= ($1.20*400 shares) - $10.95 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If CALM is above $50.00 strike price at Dec2015 expiration): +$0.00
= ($50.00-$50.00)*400 shares

Total Net Profit (If CALM is above $50.00 strike price at Dec2015 options expiration): +$469.05
= (+$469.05 options income +$0.00 dividend income +$0.00 capital appreciation)

Absolute Return (If CALM is above $50.00 strike price at Dec2015 options expiration): +2.3%
= +$469.05/$20,000.00
Annualized Return: +47.6%
= (+$469.05/$20,000.00)*(365/18 days)

The downside 'breakeven price' at expiration is at $48.80 ($50.00 - $1.20), which is 6.3% below the current market price of $52.10.

Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing Calculator, the probability of making a profit (if held until the Dec 18th, 2015 options expiration) for this Cal-Maine short Puts position is 65%. This compares with a probability of profit of 50.2% for a buy-and-hold of Cal-Maine stock over the same time period. Using this probability of profit of 65%, the expected value annualized return-on-investment (if held until expiration) is +30.9% (+47.60% * 65%), a very attractive risk/reward profile for this conservative investment.  

The 'crossover price' at expiration is $53.30 ($52.10 + $1.20).  This is the price above which it would have been more profitable to simply buy-and-hold CALM until the Dec2015 options expiration date rather than selling these Put options.