A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of Morgan Stanley (MS) covered calls as follows:Established Morgan Stanley (MS) Covered Calls for Aug2012:
07/31/2012 Bought 600 MS @ $13.63
07/31/2012 Sold 6 MS Aug2012 $14.00 Calls @ $.35
The 10-year chart below shows that Morgan Stanley is now trading at a historically low valuation relative to its book value. It is is now priced at about 40% of book value per share versus a historical norm above 100%.
With Morgan Stanley's primary financial metrics now slowly improving, the stock's downside risk seems relatively small now relative to its upside potential.
Two possible overall performance results (including commissions) for this Morgan Stanley position is as follows:
Stock Purchase Cost: $8,186.95
= ($13.63*600+$8.95 commission)
Net Profit:
(a) Options Income: +$196.55
= 600*$.35 - $13.45 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If MS price unchanged at $13.63): -$8.95
= ($13.63-$13.63)*600 - $8.95 commissions
(c) Capital Appreciation (If MS assigned at $14.00): +$213.05
= ($14.00-$13.63)*600 - $8.95 commissions
Total Net Profit(If MS price unchanged at $13.63): +$187.60
= (+$196.55 +$0.00 -$8.95)
Total Net Profit(If MS assigned at $14.00): +$409.60
= (+$196.55 +$0.00 +$213.05)
Absolute Return if Unchanged at $13.63: +2.3%
= +$187.60/$8,186.95
Annualized Return If Unchanged (ARIU): +46.5%
= (+$187.60/$8,186.95)*(365/18 days)
Absolute Return if Assigned at $14.00: +5.0%
= +$409.60/$8,186.95
Annualized Return If Assigned (ARIA): +101.5%
= (+$409.60/$8,186.95)*(365/18 days)
The downside 'breakeven price' at expiration is at $13.28 ($13.63 - $.35).
Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing calculator, the resulting probability of making a profit (if held 18 days until Aug2012 options expiration) for this Morgan Stanley covered calls position is 62.4%. This compares with a probability of profit of 50.6% for a buy-and-hold of MS over the same time period.
The 'crossover price' at expiration is $14.35 ($14.00 + $.35).
This is the price above which it would have been more profitable to simply buy-and-hold MS until August 18, 2012 (the Aug2012 options expiration date) rather than establishing the covered calls position. The probability of exceeding this crossover price at expiration is 30.7%.
