Tuesday, February 23, 2016

Established Covered Calls Position in Bank of America Corporation

Today, a covered calls position was established in Bank of America Corporation (ticker symbol BAC).  Given the Covered Calls Advisor's current Slightly Bearish overall market outlook, an in-the-money covered call position was established with a March 2016 $12.00 strike price below today's stock purchase price of $12.21.  This position also includes consideration of a $.05 quarterly dividend with an upcoming ex-div date of March 2nd. 

The Covered Calls Advisor believes that Bank of America is very underpriced with the current stock price fully 30% below its tangible book value.  With the recent dramatic decline in Bank of America's stock price, another benefit of selling these Call options now is that their implied volatility is high, so the return-on-investment potential, as detailed below, is very attractive.

As detailed below, a potential return-on-investment result is +2.9% absolute return (equivalent to +43.0% annualized return over the next 25 days) if the stock is assigned at the Mar2016 expiration on March 18th.

1. Bank of America Corporation (BAC) -- New Covered Calls Position
The transactions were:
02/23/2016 Bought 700 Bank of America Corporation shares @ $12.21
02/23/2016 Sold 7 BAC Mar2016 $12.00 Call options @ $.55
Note: a simultaneous buy/write transaction was executed.
03/02/2016 Upcoming dividend of $.05 per share

The overall performance result (including commissions) for this Bank of America covered calls position if the stock closes above the $12.00 strike price at expiration is as follows:
Stock Purchase Cost: $8,554.95
= ($12.21*700+$7.95 commission)

Net Profit:
(a) Options Income: +$371.80
= ($.55*700 shares) - $13.20 commissions

(b) Dividend Income: +$35.00
= ($.05 dividend per share x 700 shares)
(c) Capital Appreciation (If BAC assigned at $12.00 at Mar2016 expiration): -$154.95
+($12.00-$12.21)*700 - $7.95 commissions

Total Net Profit (If BAC stock called away at $12.00 at Mar2016 expiration): +251.85
= (+$371.80 +$35.00 -$154.95)

Absolute Return: +2.9%
= +$251.85/$8,554.95
Annualized Return: +43.0%
= (+$251.85/$8,554.95)*(365/25 days)

The downside 'breakeven price' at expiration is at $11.66 ($12.21 - $.55), which is 4.5% below the current market price of $12.21.

Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing Calculator, the probability of making a profit (if held until the March 18th, 2016 options expiration) for this BAC position is 59%. This compares with a probability of profit of 50.3% for a buy-and-hold of General Motors stock over the same time period. Using this probability of profit of 59%, the Expected Value annualized ROI of this investment (if held until expiration) is +25.4% (+43.0% * 59%).

The 'crossover price' at expiration is $12.81 ($12.21 + $.55 +$.05).  This is the price above which it would have been more profitable to simply buy-and-hold Bank of America stock until March 18th (the Mar2016 options expiration date) rather than establishing this covered calls position.