A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of ProShares UltraShort 20+ Year Treasury ETF (TBT) covered calls as follows:Established ProShares UltraShort 20+ Year Treasury ETF (TBT) Covered Calls for May2011:
05/02/2011 Bought 200 TBT @ $35.75
05/02/2011 Sold 2 TBT May2011 $37.00 Calls @ $.36
TBT seeks daily investment results, before fees and expenses, which correspond to twice the inverse of the daily performance of the Barclays Capital 20+ Year U.S. Treasury index. The fund normally invests at least 80% of assets to investments that, in combination, have economic characteristics that are inverse to those of the index. It also typically invests in taking positions in financial instruments, including derivatives that should have similar daily return characteristics as twice the inverse of the index.
Some readers will ask: Why establish an out-of-the-money position in an inverse ETF instead of simply an in-the-money position in a direct investment (such as TLT)? In short, an out-of-the-money position in the inverse TBT ETF enables for the possibility of capital appreciation in the underlying ETF and thus a substantially higher potential return-on-investment than could be achieved from an in-the-money TLT position (since in-the-money covered calls positions eliminate the possibility of capital appreciation in the underlying equity) if interest rates do in fact trend slightly higher.
Two possible overall performance results(including commissions) for the TBT transactions would be as follows:
Stock Purchase Cost: $7,158.95
= ($35.75*200+$8.95 commission)
Net Profit:
(a) Options Income: +$61.55
= 200*$.36 - $10.45 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If TBT unchanged at $35.75):
-$8.95 = ($35.75-$35.75)*300 - $8.95 commissions
(c) Capital Appreciation (If TBT exercised at $37.00): +$241.05
= ($37.00-$35.75)*300 - $8.95 commissions
Total Net Profit(If TBT unchanged at $35.75): +$52.60
= (+$61.55 +$0.00 -$8.95)
Total Net Profit(If TBT exercised at $37.00): +$302.60
= (+$61.55 +$0.00 +$241.05)
Absolute Return if Unchanged at $35.75: +0.9%
= +$61.55/$7,158.95
Annualized Return If Unchanged (ARIU) +16.5%
= (+$61.55/$7,158.95)*(365/19 days)
Absolute Return if Assigned at $37.00: +4.2%
= +$302.60/$7,158.95
Annualized Return If Assigned (ARIA) +81.2%
= (+$336.85/$9,533.95)*(365/24 days)
The downside breakeven price at expiration is at $35.39 ($35.75 - $.36).
Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing calculator, the resulting probability of making a profit (if held until May2011 options expiration) for this ProShares UltraShort 20+ Year Treasury ETF (TBT) covered calls position is 58.3%. This compares with a probability of profit of 51.2% for a buy-and-hold of ProShares UltraShort 20+ Year Treasury ETF (TBT) over the same time period.
