This position is a good example of a contrarian pick. Normally, the Covered Calls Advisor avoids establishing positions when there is an upcoming earnings report prior to the options expiration date, but Diamondback Energy will announce their 4th quarter earnings results on February 18th. Moreover, relative to all sectors in the economy, the Energy sector has been the worst performer for many months and its underperformance has accelerated in the past month with the price of West Texas crude oil declining from over $60 to below $50 yesterday. This precipitous decline is a combination of fear of the coronavirus spreading worldwide accompanied by the potential for a sharp decline in economic growth. As a result, most energy-related stocks are at or very near their 52-week lows and Diamondback Energy is no exception. Because of these factors, the risk of establishing this position is very high, but the potential rewards (as detailed below) are also very high. The implied volatility of FANG's options have spiked to historic levels, so the potential annualized return on investment for selling Covered Calls is very high if the stock price does not continue its steep decline. Remarkably, analysts are universally bullish on Diamondback Energy. According to Reuters, thirty-two of thirty-three analysts rate Diamondback's stock as either a 'Buy' or 'Outperform' and only one rates it as a 'Neutral'. None rate it as 'Underperform' or 'Sell'. Their average price target is 70% above its current price (one of the highest potential increases in the S&P 500).
As shown below, the potential return-on-investment result is +2.4% absolute return in 12 days (equivalent to a +73.0% annualized return-on-investment).
Diamondback Energy (FANG) -- New Covered Calls Position
02/10/2020 Bought 200 shares of Diamondback stock @ $72.18 per share
02/10/2020 Sold 2 Diamondback February 21st, 2020 $70.00 Call options @ $3.82 per share
Note: this was a simultaneous Buy/Write transaction. The Implied Volatility of the Call options was 47.4.
A possible overall performance result (including commissions) would be as follows:
Covered Calls Cost Basis: $13,673.34
= ($72.18 - $3.82) * 200 shares + $1.34 commission
Net Profit Components:
(a) Options Income: +$764.00
= ($3.82 * 200 shares)
(b) Dividend Income: +$0.00
Note: A $.1875 ex-dividend is expected soon after the Feb 18th earnings release but the upcoming ex-dividend date has not yet been declared by the company.
(c) Capital Appreciation (If FANG stock is above $70.00 strike price at the Feb 21st expiration): -$436.00
= ($70.00 -$72.18) * 200 shares
Total Net Profit: +$328.00
= (+$764.00 options income +$0.00 dividend income -$436.00 capital appreciation)
Absolute Return: +2.4%
= +$328.00/$13,673.34
Equivalent Annualized Return: +73.0%
= (+$328.00/$13,673.34)*(365/12 days)
The downside 'breakeven price' at expiration is at $68.36 ($72.18 - $3.82), which is 5.3% below the current market price of $72.18.
