This morning at 9:32am (only 2 minutes into the trading day), a Covered Calls position was established in Diamondback Energy Inc. (ticker FANG) with the simultaneous purchase of 200 shares at $109.20 per share and two November 19th, 2021 Call options were sold for $6.90 per share at the $105.00 strike price. Sometimes upon the market open on the morning immediately after the prior day's (after market close) earnings report, some investors seemingly misinterpret the report and have a knee jerk reaction and sell their shares. This was the case this morning with Diamondback Energy. The stock had closed yesterday at $111.61 and opened lower this morning and declined to a low of $108.10 before beginning to bounce back in price. The Covered Calls Advisor bought the stock at $109.20 (well below yesterday's closing price at $111.61).
Fortunately, the stock has continued its rebound during the subsequent hour and is now trading well above yesterday's closing price. Their Q3 report last evening beat estimates for both revenues and earnings. Earnings per share estimates this year are about $10.70 (a P/E Ratio of 10.2) and a further substantial EPS increase is expected for 2022. They also reported very strong cash flows so that they have been able to reduce their long-term debt by $1.3 billion already this year. They also announced an 11% dividend increase to $.50 per share (annualized dividend yield of 1.8%). In addition to and supporting their optimistic guidance for 2022 (including $4 billion free cash flow), they also announced a new $2 billion stock buyback authorization which is fully 10.4% of Diamondback's market capitalization.
The Covered Calls Advisor also normally looks at the Reuters Research target price which is based on the average of the research analysts that cover Diamondback. Their current average estimate is $125.79 (+15.2% above today's purchase price) and it is likely some analysts will increase their target prices over the next few days as they update their models based on Diamondback's excellent results.
The time value (aka extrinsic value) in the Call options was $2.70 per share = [$6.90 Call options premium
received - ($109.20 stock purchase price - $105.00 options strike
price)]. Consistent with the Dividend Capture Strategy, a moderately in-the-money Covered Calls positions was established with the Delta of the Calls at approximately 68.1 when this buy/write transaction was executed, which approximates the probability of assignment on the November 19th, 2021 options expiration date. Diamondback Energy goes ex-dividend at $.50 per share (1.8% annualized dividend yield at the current stock price) on November 9th which is prior to the Nov. 19th options expiration date, so this dividend is included in the potential return-on-investment results shown below. Also shown below, eight of the nine criteria in the Covered Calls Advisor's Dividend Capture Strategy spreadsheet were met for this position.
As shown below, a potential return-on-investment result is +3.1% absolute
return in 18 days (equivalent to a +63.3% annualized
return-on-investment if assigned on the November 19th options expiration date.
Diamondback Energy Inc. (FANG) -- New Covered Calls Position
11/02/2021 Bought 200 shares of Diamondback stock @ $109.20 per share
11/02/2021 Sold 2 Diamondback Nov. 19th, 2021 $105.00 Call options @ $6.90 per share
Note: this was a simultaneous Buy/Write transaction and the Implied Volatility of the Call options was 36.2.
11/09/2021 Upcoming ex-dividend of $.50 per share
A possible overall performance result (including commissions) would be as follows:
Covered Calls Cost Basis: $20,461.34
= ($109.20 - $6.90) * 200 shares + $1.34 commission
Net Profit Components:
(a) Options Income: +$1,378.66
= ($6.90 * 200 shares) - $1.34 commission
(b) Dividend Income: $100.00
= $.50 dividend per share x 200 shares
(c) Capital Appreciation (If FANG stock is above $105.00 strike price at the Nov. 19th expiration): -$840.00
= ($105.00 - $109.20) * 200 shares
Total Net Profit (If stock is in-the-money and therefore assigned on Nov. 19th options expiration date): +$638.66
= (+$1,378.66 options income +$100.00 dividend income -$840.00 capital appreciation)
Absolute Return (If stock assigned on May 21st options expiration date): +3.1%
= +$638.66/$20,461.34
Equivalent Annualized Return: +63.3%
= (+$638.66/$20,461.34)*(365/18 days)
These returns will be achieved as long as the stock is above the $105.00 strike price at assignment. If the stock declines below the strike price, the breakeven price of $101.80 ($109.20 -$6.90 -$.50) provides 6.8% downside protection below today's purchase price.
Using the Cox-Ross-Rubinstein Options Pricing Model, the probability of making a profit (if held until the November 19th options expiration) for this Diamondback Energy Covered Calls position is 68.1%, so the approximate expected value annualized ROI of this investment (if held until expiration) is +43.1% = (+63.3% * 68.1%), a very good result for this in-the-money Covered Calls position, especially given that an unknowns caused by an upcoming earnings report are not a factor for this position.
The Covered Calls Advisor has established a set of nine criteria to evaluate potential Covered Calls using a Dividend Capture Strategy. The minimum threshold desired to establish a position is that at least eight of these nine criteria must be achieved which is the case for this Diamondback Energy position, as shown in the chart below.
