Thursday, July 27, 2017

Established Covered Calls Position in Express Scripts Holding Co.

Today, a covered calls position was established in Express Scripts Holding Co. (ticker symbol ESRX) with an August 18, 2017 expiration.  Given the Covered Calls Advisor's current market outlook, an in-the-money covered calls position was established with the strike price of $60.00, below the stock purchase price of $62.47.

As shown in the chart below, a Covered Calls positions was established since the potential annualized return-on-investment result of +15.5% for the Covered Calls was slightly better than the +14.7% for its synthetically equivalent short Put options position

As shown above and also as detailed below, this Express Scripts Covered Calls position has the potential for a +1.0% absolute return in 23 days (equivalent to a +15.5% annualized return-on-investment).   

Express Scripts Holding Co. (ESRX) -- New Covered Calls Position
The transactions were as follows:
07/27/2017  Bought 400 Express Scripts Holding Co. shares @ $62.47
07/27/2017 Sold 4 ESRX Aug 18, 2017 $60.00 Call options @ $3.07
Note: this was a simultaneous buy/write transaction.

A possible overall performance result (including commissions) would be as follows:
Cost Basis: $23,767.55
= ($62.47 - $3.07) *400 shares + $7.55 commissions

Net Profit:
(a) Options Income: +$1,225.32
= ($3.07*400 shares) - $2.68 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If ESRX is above $60.00 strike price at Aug 18th expiration): -$992.95
= ($60.00-$62.47)*400 shares - $4.95 commissions

Total Net Profit (If ESRX is above $60.00 strike price at Aug 18, 2017 options expiration): +$232.37
= (+$1,225.32 options income +$0.00 dividends -$992.95 capital appreciation)

Absolute Return: +1.0%
= +$232.37/$23,767.55
Annualized Return: +15.5%
= (+$232.37/$23,767.55)*(365/23 days)

The downside 'breakeven price' at expiration is at $59.40 ($62.47 - $3.07), which is 4.9% below the current market price of $62.47.  A recent quantitative study titled "Which Index Options Should You Sell" link provides statistically significant insights to determine which options strike price and expiration date combination should be selected to sell.  Figure 2 in this paper shows that the front month (i.e. next month) S&P 500 options at -0.5 standard deviations on average provide a significantly better return than a basic buy-and-hold strategy.  For this Express Scripts position, the $60.00 front month option was chosen since its breakeven price is -0.7 standard deviations from the current price of $62.47 and its implied volatility was 23.0.

Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing Calculator, the probability of making a profit (if held until the Aug 18th, 2017 options expiration) for this Express Scripts Holding Co. covered calls position is 75.8%. This compares with a probability of profit of 50.3% for a buy-and-hold of Express Scripts stock over the same time period. Using this probability of profit of 75.8%, the Expected Value annualized ROI of this investment (if held until expiration) is +12.2% (+15.5% * 78.5%), an attractive result for this in-the-money covered calls position.

The 'crossover price' at expiration is $65.54 ($62.47 + $3.07).  This is the price above which it would have been more profitable to simply buy-and-hold Express Scripts stock until August 18th (the August monthly options expiration date) rather than establishing this covered calls position.

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