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Wednesday, March 21, 2018

Established Covered Calls Position in Discover Financial Services

Today, a Covered Calls position was established in Discover Financial Services (ticker DFS) for the April 20th, 2018 expiration and at the $72.50 strike price when the stock price was $74.96.  Discover's stock has declined about $5 per share since its earnings report two months ago. 

One of the Screeners developed by the Covered Calls Advisor called the 'QVG Model' ('QVG' stands for Quality, Value, and Growth) and uses a combination of factors in these three categories.  Discover Financial is one of the stocks that was identified by this screen.  Of the 25 analysts surveyed by Reuters, 19 rate Discover as either a Buy or Outperform.  Another upcoming benefit to Discover is that the 2017 tax rate for Discover was 40.7% which will decline substantially this year as a result of the new corporate tax rate law. 

As detailed below, a potential return-on-investment result is +1.87% absolute return (equivalent to +22.0% annualized return for the next 31 days) if the stock is assigned on the April 20th, 2018 options expiration date.

Discover Financial Services (DFS) -- New Covered Calls Position
The Implied Volatility of the Call options was 25.6 when these Apr 20th $72.50 Call options were sold.  The options liquidity is also good with 710 open interest contracts.

As shown in the chart below, a Covered Calls positions was chosen instead of its synthetically equivalent short 100% Cash-Secured Put options position in this instance since the annualized ROI potential is higher for the Covered Calls:
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".  Discover's next quarterly earnings report is after the April 20, 2018 options expiration date.
Also in the chart above is a column called "Intervening Ex-Div" and "NO" with an indication that "If 'YES' then complete Dividend Capture Strategy spreadsheet".  Discover's next ex-dividend date is after the April 20th expiration date.

For this position, the downside 'breakeven price' at expiration is at $71.16 ($74.96 - $3.80), which is 5.1% below the current market price of $74.96. 

Using the Black-Scholes Options Pricing Model, the probability of making a profit (if held until the April 20th, 2018 options expiration) for this Discover Covered Calls position is 67.2%, so the expected value annualized ROI of this investment (if held until expiration) is +14.8% (+22.0% * 67.2%), a satisfactory result for this moderately in-the-money Covered Calls position, especially given that there is no earnings report prior to the options expiration date.

The 'crossover price' at expiration is $76.30 = $74.96 + [$3.80 + ($74.96 - $72.50)].  This is the price above which it would have been more profitable to simply buy-and-hold Discover Financial Services stock until April 20th (the April 2018 monthly options expiration date) rather than establishing this Covered Calls position.

If you have any questions or comments to share about this position, please click on the Comments link below.

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