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Thursday, August 10, 2017

Established Covered Calls in Bank of America and Delta Air Lines

Today, two covered calls positions were established in Bank of America (BAC) and Delta Air Lines (DAL) for the September 15, 2017 options expiration date.  Given the Covered Calls Advisor's current cautious overall market outlook, moderately in-the-money covered calls positions were established in each instance. Also, there are upcoming ex-dividend dates prior to options expiration which are taken into consideration for each of these two positions.

Some potential return-on-investment results for each position are: 
  • Bank of America Corp. -- A +1.3% absolute return in 37 days (equivalent to a +13.2% annualized return-on-investment if assigned at expiration; or a +0.8% absolute return in 19 days (equivalent to a +15.2% annualized return if assigned the day prior to the August 30th ex-dividend date).    
  • Delta Air Lines Inc. -- A +2.3% absolute return in 37 days (equivalent to a +21.9% annualized return-on-investment if assigned at expiration); or a +1.6% absolute return in 11 days (equivalent to a +52.3% annualized return if assigned the day prior to the August 21st ex-dividend date).
Details for the Delta Air Lines position are provided below to explain the position further for those interested in understanding the type of thought processes and calculations underlying establishing these covered calls positions.
 
Delta Air Lines Inc. (DAL) -- New Covered Calls Position
First and foremost, is is essential to invest only in companies that you are bullish about.  Delta meets the Covered Calls Advisor's key quality, value, and growth metrics.  My bullish sentiment is shared by respected analysts including: (1) Outperform by both Schwab Equity Ratings and Reuters Research Average Rating; (2) Buy by Argus (their highest rating); (3) Strong Buy by S&P (their highest rating); (4) Barron's article last weekend on Delta was bullish, indicating a +35% stock price potential sometime during the next two years; and (5) Just today, Barclays initiated a 12-month Overweight target of $70 (See link).  Also, as shown below, the potential rate-of-return exceeds the Covered Calls Advisor's desired threshold of +20% annualized return if assigned at expiration.  Another positive occurred yesterday when the Board authorized a substantial increase in the quarterly dividend from $.2025 to $.305 and DAL stock will go ex-dividend on August 21st, before the September 15th options expiration date for this Covered Calls position.

Because of Put/Call parity, Covered Calls and Cash-Secured Puts are synthetically equivalent strategies (when done at the same strike price for the same expiration date).  However, subtle and temporary differences often exist, so just prior to executing the transactions, a comparison is made to see which strategy provides a better potential return.  For Delta, the chart below shows that the potential annualized return of +21.9% for the Covered Calls position is preferable to the +20.6% for a 100% Cash-Secured Puts position in this instance:
 

You will notice in the chart above (click on chart to view a larger and more legible version) that there is a column titled "Intervening Earnings" and "NO*" with an indication that "If 'YES' then consider avoiding position".  The "NO" in this case means that Delta does not have a quarterly earnings report prior to the options expiration.

Also in the chart above is a column called "Intervening Ex-Div" and "YES" with an indication that "If 'YES' then complete Dividend Capture Strategy spreadsheet".  This means that Delta will go ex-dividend sometime between today and the options expiration date and the Covered Calls Advisor's Dividend Capture Strategy spreadsheet should be completed to assess whether the pre-determined criteria are met to justify establishing a covered calls position for Delta.  The Covered Calls Advisor has established a set of eleven criteria to evaluate potential covered calls using a dividend capture strategy.  The minimum threshold desired to establish a position is that at least nine of these eleven criteria must be achieved.  As shown in the table below, all eleven criteria are achieved for this Delta Air Lines Inc. position.


The transactions were as follows:
08/10/2017  Bought 1,000 Delta Air Lines Inc. shares @ $49.45
08/10/2017 Sold 10 DAL Sept 15, 2017 $48.00 Call options @ $2.20
Note: this was a simultaneous buy/write transaction.
08/30/2017 $.305 ex-dividend

A possible overall performance result (including commissions) would be as follows:
Cost Basis Purchase of 1,000 shares DAL: $47,239.88
= ($49.45 -$2.20)*1,000 + $11.65 commissions

Net Profit:
(a) Options Income: +$2,200.00
= ($2.20*1,000 shares)
(b) Dividend Income: +$305.00
= $.305 per share x 1,000 shares
(c) Capital Appreciation (If DAL is above $48.00 strike price at Sep 15th expiration): -$1,454.95
= ($48.00-$49.45)*1,000 shares - $4.95 commissions

Total Net Profit (If DAL is above $48.00 strike price at Sep 15, 2017 options expiration): +$1,050.05
= (+$2,200.00 options income +$305.00 dividends -$1,454.95 capital appreciation)

Absolute Return: +2.3%
= +$1,080.05/$47,239.88
Annualized Return: +21.9%
= (+$1,080.05/$47,239.88)*(365/37 days)

The downside 'breakeven price' at expiration is at $46.945 ($49.45 - $2.20 -$.305), which is 5.1% below the current market price of $49.45. 

Using the Black-Scholes Options Pricing Model, the probability of making a profit (if held until the Sep 15th, 2017 options expiration) for this Delta Air Lines covered calls position is 70.1%, so the expected value annualized ROI of this investment (if held until expiration) is +15.8% (+22.6% * 70.1%), an attractive result for this moderately in-the-money covered calls position.

The 'crossover price' at expiration is $51.345 ($49.45 + $2.20 -$.305).  This is the price above which it would have been more profitable to simply buy-and-hold Delta Air Lines stock until September 15th (the September monthly options expiration date) rather than establishing this covered calls position.

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