Wednesday, March 13, 2013

Recent Transaction

I have another option trade to report from yesterday.  I've been wanting to pick up some more shares of Wells Fargo and was about to before it's recent climb up off from around the $35 level.  Wells Fargo, like the rest of the financial sector, had been under a lot of pressure from the financial crisis but has since returned to being a leader of the industry.  The are probably the most conservative of the too big to fail banks and if it's good enough for Warren Buffet who am I to go against him.

I decided to sell the $37 July 20th put option on Wells Fargo.  In exchange for selling someone the right to sell their shares to me I received an option premium of $1.63 per share.  After accounting for commission and fees of $8.19 I received a total of $154.81 to use now as I please.  I chose the July 20th put option since the expiration date will have the shares put to me before the ex-div date in time to receive their September payout.  Of course this assumes that they continue to follow the same schedule as the last 2 years for dividend record and payment dates.

This trade can go 1 of 3 ways.

(1) If Wells Fargo is trading below $37 on July 20th, the shares will be put to me meaning I'll have to buy 100 shares for $37.00 each.  However, since I've received option premium I can back that out from the strike price.  My cost basis for these shares if executed will be $37.00 - $154.81 / 100 + $7.95 / 100 = $35.53.  Based on the current annual dividend of $1.00 per share this would give a YOC of 2.81%.

(2) If Wells Fargo is trading above $37 on July 20th, the option will expire worthless.  This would mean I'd get to keep the full premium of $154.81 as profit.  My return is calculated as $154.81 / $3700 = 4.18% which is annualized to a 11.75% return.  Not bad considering I'm essentially setting a limit order to purchase at a price I'm comfortable and getting over a 10% return while I wait.

(3) If Wells Fargo makes a big move up in price, then the cost of the option will drop.  I could then repurchase the option to close out the position and redeploy the cash elsewhere.

All the outcomes are favorable to me.  I can purchase the shares at a price I would have bought anyways or I can receive a greater than 10% annualized return on my money.  I'm expecting a second dividend increase this year from Wells Fargo which will help to prop up the share price.  If I could choose how it would play out, WFC would be trading at $36.99 on expiration and the shares would be put to me at a big discount.  We'll see how it plays out.

This was my second trade done on margin and will be the last one until some of my cash secured puts are closed out or more cash can be added to the account.  For an explanation of margin and how it works check out this post here.  To meet the maintenance margin requirements I currently have to hold $1,072.25 in my account to secure the put, much less than the $3,700 required for the cash secured route.

I've updated my Option Summary page to reflect this trade.

7 comments:

  1. JC, I would suggest that you calculation on a return for waiting could be revised as follows:

    Because you have only held $1,072.25 in your account to secure the put, should it expire worthless, then your return for holding that money would be $154.81/$1,072.25 = 14.44%, which annualized would be a 40.54% return. Not too shabby at all!

    ReplyDelete
    Replies
    1. W2R,

      True, the return should actually be based off the margin requirement, although that value will change on a daily basis. I might start presenting the return on both a margin and cash secured basis in case anyone just starting out with options is interested in how to calculate the return.

      Thanks for stopping by!

      Delete
  2. I recently sold some puts against Wells Fargo myself. Great company, top bank in the country. Would love to actually own it at the right price.

    ReplyDelete
    Replies
    1. Marvin,

      Me too, I should have picked up more shares before now but for some reason I just never did. I like my $24 cost basis, although it's not on nearly enough shares. WFC is definitely one of the top banks and I like that they stick to the traditional banking model. Their returns might not be the same as a JPM but it's with less risk in my opinion. Their cross-selling of products is tops in the financial sector.

      Thanks for stopping by!

      Delete
  3. I really like WFC. The yield is just a little too low to get me excited right now, given my expectations for their dividend growth of <10%. The option trade was a very nice way to play this one.

    ReplyDelete
    Replies
    1. Integrator,

      I like WFC too and I think the DG going forward will be closer to the 10% mark although the next increase or two should be really nice. Their pretty conservative and I wish I had picked up some more when I first made some purchases.

      Thanks for stopping by!

      Delete
  4. The large money center banks are one area than I would avoid.

    ReplyDelete