Kinder Morgan is the largest energy transportation company in the oil and gas midstream industry. Share prices in midstream companies have been crushed recently. The Covered Calls Advisor believes that KMI is a terrific bargain at the $22.50 strike price given the huge dividend yield at that price level.
As shown below, this investment will provide a +1.2% absolute return in 22 days (which is equivalent to a +20.0% annualized return) if KMI remains above the $22.50 strike price on the December 18th options expiration date.
This potential return-on-investment result is attractive to us option sellers given this relatively conservative investment -- there is 6.1% downside protection (from the current $23.95 stock price to the $22.50 strike price). The implied volatility in the options was approximately 43 when this position was established and there are no quarterly earnings or distributions prior to the December options expiration date.
The details of the associated transactions and a potential return-on-investment result are as follows:
1. Kinder Morgan Inc. (KMI) The transactions were as follows:
11/27/2015 Bought 300 Kinder Morgan shares @ $23.95
11/27/2015 Sold 3 KMI Dec2015 $22.50 Call Options @ $1.80
A possible overall performance result (including commissions) for these Kinder Morgan Inc. covered calls is as follows:
Stock Purchase Cost: $7,192.95
= ($23.95*300+$7.95 commission)
Net Profit:
(a) Options Income: +$529.80
= 300*$1.80 - $10.20 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If KMI assigned at $22.50) = -$442.95
= ($22.50-$23.95)*300 - $7.95 commissions
Total Net Profit (If KMI assigned at $22.50): +$86.85
= (+$529.80 +$0.00 -$442.95)
Absolute Return if Assigned (at $22.50 strike price): +1.2%
= +$86.85/$7,192.95
Annualized Return If Assigned (ARIA): +20.0%
= (+$86.85/$7,192.95)*(365/22 days)
The downside 'breakeven price' at expiration is at $22.15 ($23.95 - $1.80), which is 7.5% below the current market price of $23.95.
Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing calculator, the resulting probability of making a profit (if held until Dec2015 options expiration) for this Kinder Morgan covered calls position is 72%. This compares with a probability of profit of 50.4% for a buy-and-hold of KMI stock over the same time period. Using this probability of profit of 72%, the Expected Value annualized ROI of this investment (if held until expiration) is +14.4% (+22.8% * 72%).
The 'crossover price' at expiration is $25.75 ($23.95 + $1.80). This is the price above which it would have been more profitable to simply buy-and-hold Kinder Morgan stock until Decmber 18th (the Dec2015 options expiration date) rather than establish this covered calls position.
