Today a Covered Calls position was established in CVS Health Corp. (ticker symbol CVS) when the Covered Calls Advisor's buy/write limit order was executed -- 300 shares were purchased at $62.45 and three July 31st, 2020 Call options were sold at $3.35 at the $60.00 strike price, therefore a net debit price of $59.10 which is a time value of $.90 per share [$3.35 options price - ($62.45 stock price - $60.00 strike price)]. This is a moderately in-the-money position since it was established at a price 4.1% above
the $60.00 strike price. The Delta was 69.8 when this Covered Calls position was established -- which approximates the probability that the Call options will be in-the-money on the options expiration date.
Two potential return-on-investment results for this position are highlighted below and includes the possibility of early assignment since a quarterly $.50 per share dividend that was announced by CVS this morning goes ex-dividend on July 22nd, which is prior to the July 31st options expiration date. The stock would have to move up in price by the day prior to the July 22nd ex-div date and by an amount that would cause the time value remaining in the option to decline from its $.90 value today to about $.15 or less. If this occurs, the owner of the Call options might exercise their right to purchase the stock at the $60.00 strike price, in which case the options would immediately expire worthless but the owner of the Calls would then own the stock and would capture the dividend. This outcome would be a desirable one for the Covered Calls Advisor since (as shown in the detailed calculations below) the +39.7% annualized return-on-investment (aroi) is greater than the +36.0% aroi that would be achieved if the Covered Calls position were instead assigned on the options expiration date. On the other hand, if the stock is not assigned early (on the day prior to the July 22nd ex-div date), but if the stock remains above the $60.00 strike price on the options expiration date, the position would be assigned then and the maximum potential profit at expiration of +36.0% aroi would be achieved. Another positive feature of this position is that the next quarterly earnings report on August 5th is after the July 31st options expiration date.
CVS is rated, on average, as a Moderate Buy by 27 analysts. Reuters Research indicates that currently 8 analysts have a Buy rating, 10 an Outperform, 9 have a Hold, and none have either Underperform or Strong Sell ratings; and their average target price is $79.18 (26.8% above today's purchase price). Despite the coronavirus, CVS is expected to achieve record revenues in 2020. Importantly, most of their fundamental valuation ratio metrics (such as price-to-cash-flow and price-to-sales) are currently more attractive than their prior 5-year average. On the down side, CVS added substantial long-term debt to its Balance Sheet when it acquired Aetna in November 2018 and its current return on equity (roe) of 11.1% is lower than its average for the past several years; but the encouraging news is that there remains room for improvement given the potential synergies planned by CVS management as they continue to assimilate Aetna operations into CVS.
The Covered Calls Advisor views CVS as a uniquely positioned 3-in-1 health services company. Its 9,900 retail drugstores contribute 29% of total revenue, pharmacy benefits management (47%), and health insurance (24%). Only a few competitors have even two of the three business lines that CVS has -- United Healthcare, Cigna (who owns Express Scripts), and Walmart. It remains to be seen if CVS can achieve envisioned synergies from the Aetna acquisition and therefore achieve its mission of "helping people on their way to better health".
While the Covered Calls Advisor depends primarily on fundamental valuation and competitive position factors in deciding what stocks to purchase, a minor consideration is given to technical factors. In that regard, CVS stock was down 2.3% at $62.45 today from yesterday's closing price when this Covered Calls buy/write limit order was transacted, and the Covered Calls Advisor was fortunate that the purchase
price was very near the $62.43 low price for the day. Also, the 2-day relative strength index [i.e. RSI(2)] was in oversold territory at a very low 5.4 reading, so the Implied Volatility of 28.8 when the Call options were sold was an attractive options premium to receive.
As detailed below, two potential return-on-investment results are:
- +1.5% absolute return (equivalent to +39.7% annualized
return for the next 14 days) if the stock is assigned early (business day
prior to the July 22nd ex-dividend date); OR
- +2.4%
absolute return (equivalent to +36.0% annualized return over the next 24
days) if the stock is assigned on the July 31st options expiration date.
CVS Health Corp. (CVS) -- New Covered Calls Position
The buy/write transaction was:
07/08/2020 Bought 300 CVS shares @ $62.45
07/08/2020 Sold 3 CVS 7/31/2020 $60.00 Call options @ $3.35
Note: The Call options Open Interest was 512 contracts.
07/22/2020 Upcoming quarterly ex-dividend of $.50 per share
Two possible overall performance results (including commissions) for this CVS Health Covered Calls position are as follows:
Covered Calls Cost Basis: $17,732.01
= ($62.45 - $3.35) * 300 shares + $2.01 commission
Net Profit Components:
(a) Options Income: +$1,005.00
= ($3.35 * 300 shares)
(b) Dividend Income (If option exercised early on July 21st, the business day prior to the July 22nd ex-div date): +$0.00;
or
(b) Dividend Income (If CVS stock assigned at July 31st, 2020 options expiration): +$150.00
= ($.50 dividend per share x 300 shares)
(c) Capital Appreciation (If CVS Call options assigned early on July 21st): -$735.00
+($60.00 strike price - $62.45 stock purchase price) * 300 shares; or
(c) Capital Appreciation (If shares assigned at $60.00 strike price at options expiration): -$735.00
+($60.00 - $62.45) * 300 shares
1. Total Net Profit [If option exercised on July 21st (business day prior to the July 22nd ex-dividend date)]: +$270.00
= (+$1,005.00 options income +$0.00 dividend income -$735.00 capital appreciation); or
2. Total Net Profit (If CVS shares assigned at $60.00 at July 31st, 2020 expiration): +$420.00
= (+$1,005.00 options income +$150.00 dividend income -$735.00 capital appreciation)
1. Absolute Return [If option exercised on July 21st (business day prior to ex-dividend date)]: +1.5%
= +$270.00/$17,732.01
Annualized Return (If option exercised early): +39.7%
= (+$270.00/$17,732.01)*(365/14 days); or
2. Absolute Return (If CVS shares assigned at $60.00 at July 31st, 2020 options expiration): +2.4%
= +$420.00/$17,732.01
Annualized Return (If CVS shares assigned at $60.00 at July 31st, 2020 expiration): +36.0%
= (+$420.00/$17,732.01) *(365/24 days)
Either
outcome provides a good annualized return-on-investment result -- well above the minimum desired 25.0% aroi for positions with from 20 to 30 days remaining until expiration. These returns will be achieved as long as the stock is
above the $60.00 strike price on the options expiration date. However, if the stock declines
below the strike price, the breakeven price of $58.60 ($62.45 -$3.35 -$.50)
provides 6.2% downside protection below today's stock purchase
price.
At least eight of the nine metrics used in the Covered Calls Advisor's Dividend Capture Strategy spreadsheet (see below) must be 'YES' prior to establishing a new Covered Calls position using the Covered Calls Advisor's Dividend Capture strategy. All nine criteria are achieved in this case.
Note: there has recently been a modification to Criteria #3 below. Previously, the "Annual Dividend Yield (at the Strike Price) metric was > 1.5%. This criteria is now adjusted relative to the total days until expiration, so it now reads the "Equivalent Annualized Dividend Yield (at the strike price) exceeds 6.0%." For this CVS position, the Equivalent Annualized Dividend Yield of 12.7% [calculated as ($.50/$60.00) x (365/24 days)] achieves the objective in this case since it exceeds the minimum 6.0% threshold criteria.
