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Friday, May 26, 2017

Established Covered Calls Position in General Motors Co.

Yesterday, a new covered calls position was established in General Motors Co. (ticker symbol GM) with a Jun2017 options expiration.  This position has an upcoming quarterly ex-dividends on June 7th, so the potential return for this position includes the possibility of early exercise since the ex-dividend date is prior to the June 16th options expiration date.  Given the Covered Calls Advisor's current Slightly Bearish overall market outlook, in-the-money covered calls were established. 

As detailed below, potential return-on-investment results for this GM position are: 
  • If Early Assignment: +1.2% absolute return (equivalent to +36.0% annualized return for the next 12 days) if the stock is assigned early (business day prior to June 7th ex-date); OR
  • If Dividend Capture: +2.4% absolute return (equivalent to +37.5% annualized return over the next 23 days) if the stock is assigned at the Jun2017 expiration on June 16th.

General Motors Co. (GM) -- New Covered Calls Position
The $.38 dividend of June 7th is included in the potential results detailed below.  Although unlikely, if the current time value (i.e. extrinsic value) of $.40 [$1.10 option premium - ($32.20 stock price - $31.50 strike price)] remaining in the short call option decays to about $.10 or less by June 6th (the business day prior to the ex-div date), then it is possible that the call options owner would exercise early and call the General Motors shares away to capture the dividend.

The transactions were:
05/25/2017 Bought 400 GM shares @ $32.20
05/25/2017 Sold 4 GM Jun2017 $31.50 Call options @ $1.10
Note: a simultaneous buy/write transaction was executed.
06/07/2017 Upcoming ex-dividend of $.38 per share

Two possible overall performance results (including commissions) for this General Motors covered calls position are as follows:
Stock Purchase Cost: $12,884.95
= ($32.20*400+$4.95 commission)

Net Profit:
(a) Options Income: +$437.40
= ($1.10*400 shares) - $2.60 commissions
(b) Dividend Income (If option exercised early on business day prior to June 7th ex-div date): +$0.00; or
(b) Dividend Income (If GM assigned at Jun2017 expiration): +$152.00
= ($.38 dividend per share x 400 shares)
(c) Capital Appreciation (If GM assigned early on June 6th): -$284.95
+($31.50-$32.20)*400 - $4.95 commissions; or
(c) Capital Appreciation (If GM assigned at $31.50 at Jun2017 expiration): -$284.95
+($31.50-$32.20)*400 - $4.95 commissions

1. Total Net Profit (If option exercised on day prior to June 7th ex-dividend date): +$152.45
= (+$437.40 options income +$0.00 dividend income -$284.95 capital appreciation); or

2. Total Net Profit (If GM assigned at $31.50 at Jun2017 expiration): +$304.45
= (+$437.40 options income +$152.00 dividend income -$284.95 capital appreciation)

1. Absolute Return [If option exercised on June 6th (business day prior to ex-dividend date)]: +1.2%
= +$152.45/$12,884.95
Annualized Return (If option exercised early): +36.0%
= (+$152.45/$12,884.95)*(365/12 days); or
2. Absolute Return (If GM assigned at $31.50 at Jun2017 expiration): +2.4%
= +$304.45/$12,884.95
Annualized Return: +37.5%
= (+$304.45/$12,884.95)*(365/23 days)

In this instance, assignment at Jun2017 options expiration provides a slightly higher annualized return, so that outcome is preferable -- but either outcome would provide a very attractive return-on-investment result.  These returns will be achieved as long as the stock is above the $31.50 strike price at assignment.  If the stock declines below the strike price at expiration, the breakeven price of $30.72 ($32.20 -$.38 -$1.10) provides 4.6% downside protection below today's purchase price.

Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing Calculator, the probability of making a profit (if held until the June 16th, 2017 options expiration) for this GM position is 66.8%. This compares with a probability of profit of 50.2% for a buy-and-hold of this GM stock over the same time period. Using this probability of profit of 66.8%, the expected value annualized return-on-investment (if held until expiration) is +25.1% (+37.5% maximum potential annualized return on investment * 66.8%), a very attractive risk/reward profile for this relatively conservative investment.  

The 'crossover price' at expiration is $32.92 ($32.20 - $.38 + $1.10).  This is the price above which it would have been more profitable to simply buy-and-hold GM stock until the Jun2017 options expiration date rather than selling these Put options.

The Covered Calls Advisor has established a set of eleven criteria to evaluate potential covered calls investments using a potential for dividend capture strategy.  The minimum threshold to establish a position is that at least nine of these eleven criteria must be achieved.  As detailed below for this General Motors position, ten of eleven criteria were achieved.