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Wednesday, August 30, 2017

Established Covered Calls in Best Buy Inc.

Today, a Covered Calls position was established in Best Buy Inc. (ticker symbol BBY) with an October 20th, 2017 expiration and at the $52.50 strike price.  This morning, Best Buy declared a quarterly dividend of $.34 with an ex-dividend date of September 18th, so the potential return-on-investment results for this position includes the possibility of early exercise since the ex-dividend is prior to the October 20th options expiration date.

As shown below, two potential return-on-investment results are:
  • A +3.30% absolute return (equivalent to +75.2% annualized return for the next 17 days) if the stock is assigned early (business day prior to the September 18th ex-div date); OR 
  • A +3.96% absolute return (equivalent to +27.8% annualized return over the next 52 days) if the stock is assigned on the Oct 20th, 2017 options expiration date.
Either result exceeds the Covered Calls Advisor's target for a greater than +20% potential annualized return-on-investment. 

Given the Covered Calls Advisor's current Neutral overall market outlook, an in-the-money covered calls position was established.  As shown in the chart below, a Covered Calls positions was established since the potential return-on-investment results are preferable in comparison to its synthetically equivalent short Cash-Secured Put options 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".  Best Buy does not have a quarterly earnings report prior to the options expiration date.
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 Best Buy 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 determine if the pre-determined criteria are met to justify establishing a Covered Calls position for Best Buy. 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 Best Buy position.

Best Buy Inc. (BBY) -- New Covered Calls Position
An ex-dividend occurs on August 3rd for $.2725.  In the relatively unlikely event that the current time value (i.e. extrinsic value) of $1.70 [$3.37 option premium - ($54.17 stock price - $52.50 strike price)] remaining in the short call options decays substantially (down to about $.15 or less) by September 14th (the business day prior to the ex-dividend date), there is a possibility that the Call options owner would exercise early and therefore call the 200 Best Buy shares away to capture the dividend payment.

The transactions were:
08/30/2017 Bought 200 BBY shares @ $54.17
08/30/2017 Sold 2 BBY Oct 20, 2017 $52.50 Call options @ $3.37
Note: the implied volatility for these Call options was 30.6 when this simultaneous buy/write transaction was executed.
09/18/2017 Upcoming quarterly ex-dividend of $.34 per share

Two possible overall performance results (including commissions) for this Best Buy covered calls position are as follows:
Covered Calls Position Cost Basis: $10,166.29
= ($54.17 stock price -$3.37 options price) *200 shares +$6.29 commissions

Net Profit:
(a) Options Income: +$674.00
= ($3.37*200 shares)
(b) Dividend Income (If option exercised early on Sept 15th, the business day prior to ex-div date): +$0.00; or
(b) Dividend Income (If BBY assigned at Oct 20th, 2017 expiration): +$68.00
= ($.34 dividend per share x 200 shares)
(c) Capital Appreciation (If BBY assigned): -$338.95
+($52.50 -$54.17)*200 shares - $4.95 commissions

1. Total Net Profit [If option exercised early]: +$335.05
= (+$674.00 options income +$0.00 dividend income -$338.95 capital appreciation); or
2. Total Net Profit (If Best Buy assigned at $52.50 at expiration): +$403.05
= (+$674.00 options income +$68.00 dividend income -$338.95 capital appreciation)

1. Absolute Return (If option exercised on Sept 15th, the business day prior to ex-dividend date): +3.30%
= +$335.05/$10,166.29
Annualized Return (If option exercised early -- on Sept 15th): +75.2%
= (+$335.05/$10,166.29)*(365/17 days); or
2. Absolute Return (If BBY assigned at $52.50 on Oct 20, 2017 expiration date): +3.96%
= +$403.05/$10,166.29
Annualized Return (If BBY assigned at $52.50 on Oct 20th options expiration date): +27.8%
= (+$403.05/$10,166.29)*(365/52 days)

The downside 'breakeven price' at expiration is at $50.46 ($54.17 - $3.37 -$.34), which is 6.8% below the current market price of $54.17. 

Using the Black-Scholes Options Pricing Model, the probability of making a profit (if held until the October 20th, 2017 options expiration) for this Best Buy Inc. covered calls position is 61.4%, so the expected value annualized ROI of this investment (if held until expiration) is +17.1% (+27.8% * 61.4%), an attractive result for this moderately in-the-money covered calls position.

The 'crossover price' at expiration is $57.20 ($54.17 + $3.37 -$.34).  This is the price above which it would have been more profitable to simply buy-and-hold Best Buy stock until October 20th (the October monthly options expiration date) rather than establishing this covered calls position.

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