The Covered Calls Advisor conducts weekly reviews of the five key metrics used to determine its U.S. Market Meter Indicator. The Meter was initiated on September 11, 2007 with a 'Slightly Bullish' reading. Today the indicator has been upgraded from Slightly Bullish to Bullish.
The five metrics were described in detail in a Sept 11 post -- Link.
The current readings for the five metrics are:
1. Earnings and Bond Yield Spread:
5.52%-4.64%=+.88% is Slightly Bullish.
2. Inflation: 2.1% is Bullish.
3. Current Versus Expected P/E Ratio:
(20.0-18.12)/18.12=+10.4% is Slightly Bullish.
4. Price Momentum:
(903.36-817.20)/817.20=+10.5% is Bullish.
5. Covered Calls Advisor's Gut Feel: Bullish.
Three bullish and two slightly bullish indicators. Hence, the overall weighting has shifted to a bullish outlook, which is now reflected on the 'U.S. Market Meter' Indicator at the top of the right-hand column of this blog. The meter also states the recommended investing strategy for this assessment: "The Covered Calls Advisor says: The Current Overall Stock Market Outlook is: BULLISH. The Corresponding Investing Strategy is: SELL MODERATELY OUT-OF-THE-MONEY COVERED CALLS."
By 'moderately out-of-the-money', this advisor means that the covered call positions in a portfolio of near-month covered calls should now be established on-average between 1.5% and 3.0% below the strike price.
Since this advisor's gut feeling was the deciding factor in determining that the overall rating would now change to bullish, a short explanation of this bullish gut feeling is appropriate. Previously, this advisor stated that the primary factor preventing a bullish gut feeling sentiment was "investors' discomfort regarding the current decline in the rate of economic growth and, more specifically, whether a recession can be avoided and the desired soft-landing achieved." Since that concern, the Fed made their .5% reduction and thereby demonstrated to this observer that they are committed to providing sufficient liquidity as necessary to minimize the probability of a U.S. recession. Historic studies have repeatedly demonstrated that the stock market is bullish during the first six months after an initial Fed rate cut if a recession is, in fact, avoided. This outcome now seems likely.
In addition, it is noted that we are currently in a bull market that began on 10/9/02 and in which we have so far had a 100.5% increase as measured by the S&P 500. (Note: A bull market is defined as a rally exceeding +20% after a period of a 20+% decline).
Prior to this one, there have been five bull markets since 1970. This advisor analyzed the Earnings Yield to Bond Yield Spread at the end of each of these bull markets and discovered that these bull markets did not end until the Earnings Yield was more than 1% lower than the 10-Yr Treasury Bond Yield. In fact, the actual yield differences at the end of these five bull markets were -1.29%, -2.06%, -4.27%, -3.24%, and -1.39%. In comparison, as shown in #1 above, the current yield spread is +.88%. In this advisor's opinion, this bodes well for the likelihood of a continuation of the current bull market.
Regards and Godspeed
Sunday, October 7, 2007
Saturday, October 6, 2007
The Answer Is: Between 7 and 25
So then: What is the Question?
Perhaps you might think the question is: How many different jobs am I likely to have in my lifetime? Or how about: How many houses will I look at before I buy one? These are both questions that could reasonably precede the answer "between 7 and 25". However, the question the Covered Calls Advisor is looking for is: How many covered call positions should I have in my portfolio?
This advisor intends to maintain between 7 and 25 covered call positions in the Covered Calls Advisor Portfolio (CCAP). It is recommended that you also consider the advantages of maintaining between 7 and 25 positions in your own portfolio.
To specify why 7 to 25 is the recommended range, let’s consider two questions:
(1) What are the fewest number of covered call positions I should own?; and
(2) What are the largest number of covered call positions I should own?
The first question above is one that I often receive. On the one hand, people usually want to be adequately diversified, but on the other hand they have limited resources to invest. Although there are some very successful investors that do not practice diversification (for example Warren Buffett and Ken Heebner), the overwhelming majority of successful investors and financial advisors do recommend diversification, as do I. So the first question really becomes: What are the fewest number of covered call positions needed to be adequately diversified?
There are three primary components related to diversification: Asset Allocation, Sector Diversification, and Position Sizing -- Each of these will be discussed in greater depth in future postings. For now, this advisor will simply present my own guidelines for diversification:
(a) Asset Allocation
Domestic Equities – 70% (roughly 40% large cap and 30% mid/small cap)
International Equities – 25%
Fixed Income – 0%
Cash – 5%
Note: This advisor maintains an aggressive investing approach. You might be more conservative in your own portfolio with a lower percentage of equities and a higher percentage of fixed income and cash.
(b) Sector Diversification - Invest in at least five of the six sectors listed below:
Consumer (includes both Consumer Staples and Consumer Discretionary)
Energy (including Materials)
Financial
Health Care
Industrial (including Telecom and Utilities)
Information Technology
(c) Position Sizing – No single position more than 20% of total. This is the same guideline used by this advisor’s broker, Charles Schwab & Co.
So again, what is the recommended minimum number of positions?
To diversify across all sectors shown above, a minimum of six positions would need to be established. And to achieve a 25% allocation in international, without exceeding the maximum 20% position size for each position, a minimum of two international positions would be required for a total of 8 covered call positions. The Covered Calls Advisor recommends that you be invested in at least 5 of the 6 sectors listed above at all times. So although not recommended, it is acceptable to not be invested in one of the six sectors at any given time if you feel strongly that a particular sector will under-perform the others in the near future. Therefore, the recommended minimum is 7 positions (5 different sectors plus 2 international). This can be achieved while still honoring the max 20% limit for any single position).
The second question above is as important as the first:
What is the maximum number of positions I should own? The short answer is: ‘no more than you can continually monitor without feeling overburdened by the research and recordkeeping’. The second part of this statement, ‘without feeling overburdened by the research and recordkeeping’, is the most important. To be a successful investor in the long-run, which is our primary objective, we need to feel both mentally stimulated as well as to receive enjoyment from the research we are undertaking; but without feeling burdened by it.
Now for the first part, ‘no more than you can continually monitor’. What does ‘continually monitor’ mean? There are four primary aspects to ‘continually monitoring’ a portfolio:
(a) Read all news on the companies – Preferably daily, but at least once a week.
(b) Monitor prices – Preferably daily, but at least weekly.
(c) Listen to earnings conference calls – Quarterly.
(d) Maintain a good understanding of all positions currently held in your portfolio – That is, you should be able to name every equity held in your portfolio from memory without having to look them up; and be able to provide a clear and concise rationale for each position (4 to 6 sentences) as to why it is now a good covered call investment opportunity.
For this advisor, 25 is the upper limit for being able to perform all four of the ‘monitoring’ tasks above and also ‘without feeling overburdened’. However, while 25 is the max for this advisor, it can also be stated that my most common range is from 10 to 20 total covered call positions at any given time. That is my ‘comfort zone’ so to speak; that is, where I feel I am achieving both very good diversification while simultaneously maintaining a good handle on key information about each of the companies -- and most importantly, really enjoying the whole process! The max number for you might be different; perhaps 10, or 20, or even 30 – and that’s fine! Find your own personal ‘comfort zone’.
Regards and Godspeed
Perhaps you might think the question is: How many different jobs am I likely to have in my lifetime? Or how about: How many houses will I look at before I buy one? These are both questions that could reasonably precede the answer "between 7 and 25". However, the question the Covered Calls Advisor is looking for is: How many covered call positions should I have in my portfolio?
This advisor intends to maintain between 7 and 25 covered call positions in the Covered Calls Advisor Portfolio (CCAP). It is recommended that you also consider the advantages of maintaining between 7 and 25 positions in your own portfolio.
To specify why 7 to 25 is the recommended range, let’s consider two questions:
(1) What are the fewest number of covered call positions I should own?; and
(2) What are the largest number of covered call positions I should own?
The first question above is one that I often receive. On the one hand, people usually want to be adequately diversified, but on the other hand they have limited resources to invest. Although there are some very successful investors that do not practice diversification (for example Warren Buffett and Ken Heebner), the overwhelming majority of successful investors and financial advisors do recommend diversification, as do I. So the first question really becomes: What are the fewest number of covered call positions needed to be adequately diversified?
There are three primary components related to diversification: Asset Allocation, Sector Diversification, and Position Sizing -- Each of these will be discussed in greater depth in future postings. For now, this advisor will simply present my own guidelines for diversification:
(a) Asset Allocation
Domestic Equities – 70% (roughly 40% large cap and 30% mid/small cap)
International Equities – 25%
Fixed Income – 0%
Cash – 5%
Note: This advisor maintains an aggressive investing approach. You might be more conservative in your own portfolio with a lower percentage of equities and a higher percentage of fixed income and cash.
(b) Sector Diversification - Invest in at least five of the six sectors listed below:
Consumer (includes both Consumer Staples and Consumer Discretionary)
Energy (including Materials)
Financial
Health Care
Industrial (including Telecom and Utilities)
Information Technology
(c) Position Sizing – No single position more than 20% of total. This is the same guideline used by this advisor’s broker, Charles Schwab & Co.
So again, what is the recommended minimum number of positions?
To diversify across all sectors shown above, a minimum of six positions would need to be established. And to achieve a 25% allocation in international, without exceeding the maximum 20% position size for each position, a minimum of two international positions would be required for a total of 8 covered call positions. The Covered Calls Advisor recommends that you be invested in at least 5 of the 6 sectors listed above at all times. So although not recommended, it is acceptable to not be invested in one of the six sectors at any given time if you feel strongly that a particular sector will under-perform the others in the near future. Therefore, the recommended minimum is 7 positions (5 different sectors plus 2 international). This can be achieved while still honoring the max 20% limit for any single position).
The second question above is as important as the first:
What is the maximum number of positions I should own? The short answer is: ‘no more than you can continually monitor without feeling overburdened by the research and recordkeeping’. The second part of this statement, ‘without feeling overburdened by the research and recordkeeping’, is the most important. To be a successful investor in the long-run, which is our primary objective, we need to feel both mentally stimulated as well as to receive enjoyment from the research we are undertaking; but without feeling burdened by it.
Now for the first part, ‘no more than you can continually monitor’. What does ‘continually monitor’ mean? There are four primary aspects to ‘continually monitoring’ a portfolio:
(a) Read all news on the companies – Preferably daily, but at least once a week.
(b) Monitor prices – Preferably daily, but at least weekly.
(c) Listen to earnings conference calls – Quarterly.
(d) Maintain a good understanding of all positions currently held in your portfolio – That is, you should be able to name every equity held in your portfolio from memory without having to look them up; and be able to provide a clear and concise rationale for each position (4 to 6 sentences) as to why it is now a good covered call investment opportunity.
For this advisor, 25 is the upper limit for being able to perform all four of the ‘monitoring’ tasks above and also ‘without feeling overburdened’. However, while 25 is the max for this advisor, it can also be stated that my most common range is from 10 to 20 total covered call positions at any given time. That is my ‘comfort zone’ so to speak; that is, where I feel I am achieving both very good diversification while simultaneously maintaining a good handle on key information about each of the companies -- and most importantly, really enjoying the whole process! The max number for you might be different; perhaps 10, or 20, or even 30 – and that’s fine! Find your own personal ‘comfort zone’.
Regards and Godspeed
Wednesday, October 3, 2007
Defining Two Important Covered Call Terms
In a previous post (’Ten Factors’ link), ten factors were identified that are used by this Covered Calls Advisor to analyze potential covered call positions for investment worthiness. Of these ten however, two primary factors were identified as being particularly important to us covered call investors:
1. Annualized Return-On-Investment(ROI) %
2. Downside Breakeven Protection %
To understand these two terms, we will first describe and show the formulas for how they are calculated. Then we will further clarify ‘how-to’ calculate them by performing the calculations using a specific example (Hewlett Packard).
1. Annualized ROI % - Two percentages are calculated here that are relevant to the covered call selection process:
(a) Annualized Return If Unchanged (ARIU) – more fully described as the annualized return-on-investment % if the stock price is unchanged at expiration compared with its current price. The formula is:
ARIU= ($ option premium/$ original investment)*(365 days/# days until expiration)*100
(b) Annualized Return If Exercised (ARIE) – more fully described as the annualized return-on-investment % if the stock price is above the option strike price at expiration and is therefore exercised (Note: other synonymous terms for ‘exercised’ are ‘assigned’ and ‘called’). This is the best-case scenario wherein the maximum return potential for the covered call position is achieved. The HPQ example below shows that the percentages for ARIU and ARIE are identical for a covered call position that is in-the-money (ITM) when originally established. However, the ARIE percentage will be higher than the ARIU if the stock is out-of-the-money (OTM) when the covered call position is established. In this OTM instance, the formula is:
ARIE = [((option strike price – current stock price + option bid price)/current stock price)*(365 / # days until expiration)]*100
2. Downside Breakeven Protection (DBP) % -- This measure shows what % the current stock price would have to fall by the expiration date to reach a breakeven point (i.e. $0 profit and $0 loss) on the total covered call position. The formula is simply:
DBP=($ option premium/$ stock price)*100
Note: Commissions should normally be included in the calculations above, but are excluded here to make the formulas somewhat easier to understand.
Now we’ll use a specific option chain for Hewlett Packard (HPQ) to show how the calculations are made in a specific circumstance. The pertinent information for the two closest strike prices are:
Hewlett Packard(HPQ) Current Price = $50.42
Oct07 50 Bid Price = $1.65
Oct07 52.5 Bid Price = $.40
Example 1: Sell In-the-Money (ITM) Covered Call:
On 10/3/07: Buy 100 HPQ @ $50.42 = $5,042
Sell to Open (STO) 1 Oct 50 @ $1.65 = $165
ARIU = +52.4% = [($165-($5,042-$5,000))/$5,042]*(365/17 days)
ARIE = +52.4% -- Same as ARIU since ITM
DBP = (1.65/50.42)*100 = 3.3%
Example 2: Sell Out-of-the-Money (OTM) Covered Call:
On 10/3/07: Buy 100 HPQ @ $50.42 = $5,042
Sell to Open (STO) 1 Oct 52.5 @ $.40 = $40
ARIU = +17.0% = ($40/$5,042)*365/17 days)*100
ARIE = +105.5% = ((52.5-50.42+.40)/50.42)*365/17 days)*100
DBP = (.40/50.42)*100 = 0.8%
Notice the inverse relationship between these two key factors – annualized ROI % and downside breakeven protection %. When both factors are considered together, they demonstrate the essence of the risk-reward principle. That is, in order to achieve greater potential reward (17.0% and 105.5% in example #2 above), we need to be willing to accept greater risk (i.e. less downside breakeven protection; only 0.8% in example #2 above). Conversely, we can achieve less risk (for example 3.3% downside breakeven protection in example #1 above) but with less maximum potential reward (+52.4% in example #1 above). Ultimately, each of us covered call investors must find our own personal risk/reward comfort level and make our covered call investment decisions accordingly.
For this covered calls advisor, a minimum threshold of +30.0% ARIU and >.06% per-day DBP is required. Example #1 above exceeds these criteria (52.4% ARIU and .19% (3.3%/17 days) per-day DBP; so this position would be a viable candidate for further analysis as a possible covered call investment (remember, this advisor analyzes eight additional factors before determining whether a particular covered call position is a buy). In Example #2 above, the covered call position does not meet the minimum threshold criteria and therefore would not be given additional consideration. As implied earlier, your thresholds might be different from that of the Covered Calls Advisor since they are dependent on your own personal risk tolerance. If you’re more cautious, then your ARIU minimum would be lower and your DBP threshold higher. Conversely, if you are more risk tolerant you might have a somewhat higher ARIU minimum but with an accompanying DBP threshold even lower than this advisor’s .06% per-day minimum.
These concepts might be somewhat confusing at this moment, but please persevere. If necessary, re-read the article above to gain a better understanding of its contents; or click on the ‘Comment’ link below to provide a specific comment or ask a question.
Regards and Godspeed
1. Annualized Return-On-Investment(ROI) %
2. Downside Breakeven Protection %
To understand these two terms, we will first describe and show the formulas for how they are calculated. Then we will further clarify ‘how-to’ calculate them by performing the calculations using a specific example (Hewlett Packard).
1. Annualized ROI % - Two percentages are calculated here that are relevant to the covered call selection process:
(a) Annualized Return If Unchanged (ARIU) – more fully described as the annualized return-on-investment % if the stock price is unchanged at expiration compared with its current price. The formula is:
ARIU= ($ option premium/$ original investment)*(365 days/# days until expiration)*100
(b) Annualized Return If Exercised (ARIE) – more fully described as the annualized return-on-investment % if the stock price is above the option strike price at expiration and is therefore exercised (Note: other synonymous terms for ‘exercised’ are ‘assigned’ and ‘called’). This is the best-case scenario wherein the maximum return potential for the covered call position is achieved. The HPQ example below shows that the percentages for ARIU and ARIE are identical for a covered call position that is in-the-money (ITM) when originally established. However, the ARIE percentage will be higher than the ARIU if the stock is out-of-the-money (OTM) when the covered call position is established. In this OTM instance, the formula is:
ARIE = [((option strike price – current stock price + option bid price)/current stock price)*(365 / # days until expiration)]*100
2. Downside Breakeven Protection (DBP) % -- This measure shows what % the current stock price would have to fall by the expiration date to reach a breakeven point (i.e. $0 profit and $0 loss) on the total covered call position. The formula is simply:
DBP=($ option premium/$ stock price)*100
Note: Commissions should normally be included in the calculations above, but are excluded here to make the formulas somewhat easier to understand.
Now we’ll use a specific option chain for Hewlett Packard (HPQ) to show how the calculations are made in a specific circumstance. The pertinent information for the two closest strike prices are:
Hewlett Packard(HPQ) Current Price = $50.42
Oct07 50 Bid Price = $1.65
Oct07 52.5 Bid Price = $.40
Example 1: Sell In-the-Money (ITM) Covered Call:
On 10/3/07: Buy 100 HPQ @ $50.42 = $5,042
Sell to Open (STO) 1 Oct 50 @ $1.65 = $165
ARIU = +52.4% = [($165-($5,042-$5,000))/$5,042]*(365/17 days)
ARIE = +52.4% -- Same as ARIU since ITM
DBP = (1.65/50.42)*100 = 3.3%
Example 2: Sell Out-of-the-Money (OTM) Covered Call:
On 10/3/07: Buy 100 HPQ @ $50.42 = $5,042
Sell to Open (STO) 1 Oct 52.5 @ $.40 = $40
ARIU = +17.0% = ($40/$5,042)*365/17 days)*100
ARIE = +105.5% = ((52.5-50.42+.40)/50.42)*365/17 days)*100
DBP = (.40/50.42)*100 = 0.8%
Notice the inverse relationship between these two key factors – annualized ROI % and downside breakeven protection %. When both factors are considered together, they demonstrate the essence of the risk-reward principle. That is, in order to achieve greater potential reward (17.0% and 105.5% in example #2 above), we need to be willing to accept greater risk (i.e. less downside breakeven protection; only 0.8% in example #2 above). Conversely, we can achieve less risk (for example 3.3% downside breakeven protection in example #1 above) but with less maximum potential reward (+52.4% in example #1 above). Ultimately, each of us covered call investors must find our own personal risk/reward comfort level and make our covered call investment decisions accordingly.
For this covered calls advisor, a minimum threshold of +30.0% ARIU and >.06% per-day DBP is required. Example #1 above exceeds these criteria (52.4% ARIU and .19% (3.3%/17 days) per-day DBP; so this position would be a viable candidate for further analysis as a possible covered call investment (remember, this advisor analyzes eight additional factors before determining whether a particular covered call position is a buy). In Example #2 above, the covered call position does not meet the minimum threshold criteria and therefore would not be given additional consideration. As implied earlier, your thresholds might be different from that of the Covered Calls Advisor since they are dependent on your own personal risk tolerance. If you’re more cautious, then your ARIU minimum would be lower and your DBP threshold higher. Conversely, if you are more risk tolerant you might have a somewhat higher ARIU minimum but with an accompanying DBP threshold even lower than this advisor’s .06% per-day minimum.
These concepts might be somewhat confusing at this moment, but please persevere. If necessary, re-read the article above to gain a better understanding of its contents; or click on the ‘Comment’ link below to provide a specific comment or ask a question.
Regards and Godspeed
Tuesday, October 2, 2007
Roll Up Adjustment -- Fluor
The Covered Calls Advisor Portfolio (CCAP) covered call position in Fluor (FLR) was rolled up today (10/02/07) from the Oct 140 to the Oct 150. A good-til-cancelled debit limit roll up order was placed at $7.10, and was executed as follows:
Buy-to-Close (BTC) FLR Oct 140 @ $11.60
Sell-to-Open (STO) FLR Oct 150 @ $4.50
Net Debit on Roll Up $7.10
The ‘net debit to strike price difference ratio’ was 71% [$7.10/($150-$140)], which meets this advisor’s threshold of rolling up only if the ratio is <75%.
A summary of the FLR transactions so far is as follows:
Previously: Initial FLR post
9/18/07 BTO 100 FLR @ $138.17
9/18/07 STO 1 FLR Oct 140 @$4.90
Today:
10/2/07 BTC 1 FLR Oct 140 @ $11.60
10/2/07 STO 1 FLR Oct 150 @ $4.50
Note: FLR stock was trading at $150.16 today when the roll up transaction was executed.
The result for the completed Oct 140 covered call position and the status on the newly established Oct 150 covered call position (including commissions) are each summarized below:
(a) Completed Covered Call Position:
Original Stock Investment 9/18/07 – Purchased 100 shares @ $138.17
= $138.17*100 + $9.95 commission = ($13,826.95)
Change in Stock Value ($150.16-$138.17)*100 = $1,199.00
Change in Options Value = Original Income of $478.30($4.90*100-$10.70 commission)minus Option Buyback Cost $1,170.70($11.60*100+$10.70 commission) = -$692.40 ($478.30-$1,170.70)
Net Change ($1,199.00-$692.40) = $506.60
ANNUALIZED RETURN ON INVESTMENT:
(506.60/13,826.95)*(365/14 days) = 95.5%
(b) New Covered Call Position Established:
10/02/07 Retained 100 FLR at $150.16 = ($15,016)
10/02/07 Sold 1 OCT07 150 Call @ $4.50 = $439.30 ($4.50*100-$10.70 commission)
Annualized Return If Unchanged (ARIU) 58.6%
Annualized Return If Exercised (ARIE) 58.6%
Downside Breakeven Protection 3.0%
In the prior post on this blog titled ‘Rockin’ and Rollin’ – When to ‘Roll Up’ a Covered Call Position’, a specific methodology (more detailed than the ‘net debit to strike price difference’ method is provided for comparison purposes on two possible roll up decision alternatives: (1) maintain the existing position and do nothing; or (2) roll up to a higher strike price. Here’s an excerpt from that post as it pertains to the present Fluor holding:
Here’s the key: Analyze the two option position alternatives as if you don’t already have a short options position.Given that you already own 100 shares of FLR now valued at $150.16, would you prefer for the time period between now (10/02/07) and October expiration (10/20/07) to sell 1 Oct 140 option (priced at $11.60 on 10/02/07) or 1 Oct 150 option (priced at $4.50 on 10/02/07)? The primary factors for the two alternatives are as follows:
(1) Keep the covered call Oct 140 position for the remaining 18 days until October expiration:
Annualized Return If Unchanged (ARIU) = 19.4%
Annualized Return If Exercised (ARIE) = 19.4%
Downside Breakeven Protection = 7.7%
(2) Switch to a covered call Oct 150 position for the remaining 18 days until October expiration:
Annualized Return If Unchanged (ARIU) = 58.6%
Annualized Return If Exercised (ARIE) = 58.6%
Downside Breakeven Protection = 3.0%
As also described in the prior blog post, this advisor’s own personal guideline is to roll up to the higher strike price if two conditions are met: (1) The ARIU is more than 15% greater for the new position [in this case it was 39.2% higher (58.6%-19.4%)]; and (2) The per-day downside protection is >.06% [in this case it was .17% (3.0%/18 days until expiration)]. Since both criteria were met, the decision was made to roll up the covered call position.
Buy-to-Close (BTC) FLR Oct 140 @ $11.60
Sell-to-Open (STO) FLR Oct 150 @ $4.50
Net Debit on Roll Up $7.10
The ‘net debit to strike price difference ratio’ was 71% [$7.10/($150-$140)], which meets this advisor’s threshold of rolling up only if the ratio is <75%.
A summary of the FLR transactions so far is as follows:
Previously: Initial FLR post
9/18/07 BTO 100 FLR @ $138.17
9/18/07 STO 1 FLR Oct 140 @$4.90
Today:
10/2/07 BTC 1 FLR Oct 140 @ $11.60
10/2/07 STO 1 FLR Oct 150 @ $4.50
Note: FLR stock was trading at $150.16 today when the roll up transaction was executed.
The result for the completed Oct 140 covered call position and the status on the newly established Oct 150 covered call position (including commissions) are each summarized below:
(a) Completed Covered Call Position:
Original Stock Investment 9/18/07 – Purchased 100 shares @ $138.17
= $138.17*100 + $9.95 commission = ($13,826.95)
Change in Stock Value ($150.16-$138.17)*100 = $1,199.00
Change in Options Value = Original Income of $478.30($4.90*100-$10.70 commission)minus Option Buyback Cost $1,170.70($11.60*100+$10.70 commission) = -$692.40 ($478.30-$1,170.70)
Net Change ($1,199.00-$692.40) = $506.60
ANNUALIZED RETURN ON INVESTMENT:
(506.60/13,826.95)*(365/14 days) = 95.5%
(b) New Covered Call Position Established:
10/02/07 Retained 100 FLR at $150.16 = ($15,016)
10/02/07 Sold 1 OCT07 150 Call @ $4.50 = $439.30 ($4.50*100-$10.70 commission)
Annualized Return If Unchanged (ARIU) 58.6%
Annualized Return If Exercised (ARIE) 58.6%
Downside Breakeven Protection 3.0%
In the prior post on this blog titled ‘Rockin’ and Rollin’ – When to ‘Roll Up’ a Covered Call Position’, a specific methodology (more detailed than the ‘net debit to strike price difference’ method is provided for comparison purposes on two possible roll up decision alternatives: (1) maintain the existing position and do nothing; or (2) roll up to a higher strike price. Here’s an excerpt from that post as it pertains to the present Fluor holding:
Here’s the key: Analyze the two option position alternatives as if you don’t already have a short options position.Given that you already own 100 shares of FLR now valued at $150.16, would you prefer for the time period between now (10/02/07) and October expiration (10/20/07) to sell 1 Oct 140 option (priced at $11.60 on 10/02/07) or 1 Oct 150 option (priced at $4.50 on 10/02/07)? The primary factors for the two alternatives are as follows:
(1) Keep the covered call Oct 140 position for the remaining 18 days until October expiration:
Annualized Return If Unchanged (ARIU) = 19.4%
Annualized Return If Exercised (ARIE) = 19.4%
Downside Breakeven Protection = 7.7%
(2) Switch to a covered call Oct 150 position for the remaining 18 days until October expiration:
Annualized Return If Unchanged (ARIU) = 58.6%
Annualized Return If Exercised (ARIE) = 58.6%
Downside Breakeven Protection = 3.0%
As also described in the prior blog post, this advisor’s own personal guideline is to roll up to the higher strike price if two conditions are met: (1) The ARIU is more than 15% greater for the new position [in this case it was 39.2% higher (58.6%-19.4%)]; and (2) The per-day downside protection is >.06% [in this case it was .17% (3.0%/18 days until expiration)]. Since both criteria were met, the decision was made to roll up the covered call position.
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